Insights from a Mortgage Professional

Posted at 4:10 AM, Sep. 30, 2008

Here is an insight provided from Jamie Simpson from Guaranteed Rate to help consumers and real estate professionals gain some clairity to the scare of recent headlines.  Feel free to give him a call with any questions.

I want to provide insight to the credit crisis of last week because I know there is a lot of confusion based upon scary headlines of the past several days.  My hope is to clarify some terms and explain what actually happened, what it means for the economy, the real estate market and your mortgage for the next 6-9 months.

What Happened: The Treasury Purchased Assets, Not a Bail Out, Taxpayer Might Profit

Under normal circumstances, the government would let AIG and Fannie Mae and Freddie Mac fail.  Lehman Brothers was allowed to fail (its CEO Fuld sold his shares for only 20 cents each and lost $145,000,000 since January), and Bear Sterns was bought by JP Morgan with a collar loan from the Treasury.  But these were not normal circumstances. The government bought assets totaling $700B in delinquent mortgages because no other institution was willing to buy these highly leveraged bad debts, nor did any other institution have a balance sheet large enough to absorb them.  Institutional banks stopped lending to each other and hoarded cash because they feared they would not get paid back. Only the Treasury was trusted to pay them back.  The troubled assets were simply too large, too complex, and too leveraged, sometimes 40:1.  They need to be de-leveraged and appraised to allow for an orderly trade of these assets.  Once clearing prices are set, institutions will trade them.  Capital of approximately $350M will need to be raised.  The Treasury valued the assets at $700B, which is at a discounted par value of $1 trillion.  It represents 10% of the system's mortgage exposure, and 100% of the delinquent mortgage exposure.  The Treasury borrowed money to buy these assets, and might make or lose money when these assets are sold.  The difference is what we taxpayers are responsible for.

What It Means for Inflation, Credit, and Housing; Good News, Bad News

Whenever the government borrows massive amounts of money, it crowds out other players such as small businesses who need cash to run their business.  So the problems on Wall Street will trickle down to Main Street.  The good news is that because the assets need to be de-leveraged, this will be deflationary.  You can expect low inflation in the next 6-9 months, as well as low mortgage rates.  The bad news is that the consumer is under stress, he feels that tighter credit has eroded his wealth, and unemployment is now rising.  He will cut back on discretionary consumption.  The key driver of inflation is unit labor costs, and in this down business cycle labor costs will be deflated because of the contraction in employment.  The risks are thus higher for a contraction in the economy.

The key is the stabilization of prices in the housing market, which has been occurring nationally.  Housing inventory has slowly been absorbed over the past 14 months, and it does take fewer months to sell today.  The National Association of Realtors believes housing will begin to turn around in earnest in 1Q2009.  Prices are firming, we are nearing a bottom, and auction inventory is reducing.  The Treasury's sale of troubled assets will speed the dissolution of housing inventory. Nonetheless, government policy may be necessary to limit the downside, possibly through more liquidity of reserves into the system, and fiscal stimulus.  It does not appear that the Fed needs to lower its Fed Funds rate of 2% because its real rate is actually negative because inflation is higher than 2%, so businesses and banks are borrowing for free.  It seems to be stimulative enough for now.  If the Fed adds liquidity into the system and the liquidity is not going to goods and services (like the stimulus earlier in the spring), but instead goes to purchase assets, this is not inflationary.

Bottom-line, it is rare to see low mortgage rates and low housing prices.  Usually the two are inverse to each other -- high prices, low rates and vice-versa.  It is a great time to buy, and the market will come back sooner than expected.  Get ready because the opportunities are plentiful now.  If you have good credit and income, you can get almost any loan.  If your credit needs repair, please call me because lenders are charging up to 1% higher rates for FICOs less than 660.

The costly restrictions by Fannie Mae and Freddie Mac on investment properties need to be removed to sell more property.  Today, it can cost an investor up to 4% in points to buy a condo or a 4 flat when in February it was only 1.5%.  Also, as of January 1 2009 no investor with more than 4 mortgages can get an investor loan from Fannie and Freddie.  As long as the investor has 20% down and 640 FICO scores, this makes no sense in this market.

Where We Go From Here: GDP Here and Abroad, Taxes, Undisciplined Government Spending

The current financial crisis, Boeing strike, HP layoffs, and the remnants from Hurricane Ike will be felt and we will likely have a volatile period immediately following these announcements, but the underlying trend for most companies is strong today.  Except for the financial sector (Fannie Mae and Freddie Mac were replaced by two other companies) and some discretionary consumer-based companies, the cash flow and earnings of businesses is generally strong for the 3rd Quarter. The GDP was 3.3% in the 2nd Quarter ending June 30.  Yet the risks are still higher for a contraction in the economy going forward.

The US is farther along in the downward global business cycle than is Japan and Europe.  As their economies stall, look to the ECB to consider lowering its rates from 5% to be closer to our own 2%.  The interest rate differential is not favorable now but look for the ECB to change that. The US is also likely to exit from this downward business cycle faster than Japan and Europe.  But our exports will be hurt, and that has been a bright spot for the US.

More tax revenue than ever was brought into the Treasury's coffers in 2007 and 2008, yet the federal budget deficit is out of control, currently about $500B.  That means the government is borrowing almost $1 out of every $5 it spends.  The government has to get its spending under control because plenty of tax revenue is generated by the taxpayer, and the taxpayer is tapped out.  The national debt is also approaching $10 trillion, which means that rising interest payments are being made overseas to pay the coupon on the Treasuries held by foreigners.  Tax increases by Herbert Hoover in 1932 from 28% to 63% on the top earners to end the Depression actually prolonged it. We're not in a Depression, which had a 40% foreclosure rate, but clearly any tax policy going forward also needs massive cuts in spending to reduce the budget deficit.

Jamie Simpson
VP of Mortgage Lending
Guaranteed Rate, Inc
P. (773) 290-0525
C. (773) 251-7187
F. (773) 435-0623
jamie@guaranteedrate.com