Premier Mortgage Group

The end of July usually marks the quietest time of the year for markets. Big-shot bankers are away from trading desks, loading up for August in the Hamptons — in the old days to kick sand at 98-pound weaklings, today to compete for most-obnoxious conduct on a beach with a cell phone.

This year isn’t so quiet. The slowdown beginning in May is now more trend than air-pocket, and every new data point matters. This morning’s news of sub-par 2^nd Quarter GDP (+2.4%, half by inventory accumulation) has hit stocks and helped bonds and mortgages. On Monday jumpy markets whipsawed after “New home sales soared 24% in June!” turned out to be a minor bounce from a deeper hole, May revised to a 53% drop from April.

June orders for durable goods were forecast to rise .5% (core), but fell .6%. The Conference Board’s index of consumer confidence plunked to 50.4; in prior recoveries averaged over 100, at bottoms of prior recessions, 72. The Fed’s July “beige book” was distinctly softer than June, but insisted that economic activity continued to “increase.”

A national consensus is now deep and broad: we have borrowed too much, we must stop new borrowing, and must pay back our debts. We must “deleverage,” right now.

That’s not a new concept on the right, among gold bugs, or the “Austrian school” loons, but the whole center agrees. But to find certified leftie Roger Lowenstein in the Sunday Times making the same argument? Unprecedented in US political economics.

The foundation for this consensus is the three fright charts run everywhere: total US debt $55 trillion, 3.5 times GDP; household debt 125% of household income; and US Treasury debt soon to pass 100% of GDP. A few Krugmanites advocate more Treasury borrowing and stimulus spending, but nobody argues for more private borrowing.

Except me. Not a lot, but enough credit to support businesses and asset values.

Deleveraging mob dogma recites the amount of debt, but never its cost, structure, or security, and the mob has no plan. The first flaw in that approach: a prudent person can carry a lot more debt at 5% today than at double-digit rates throughout the ‘70’s and ‘80s, the baseline in the fright charts. Levels of debt are large, but payments relative to income are today within long-term historical norm.

Risky debt (to borrower and lender alike) is unsecured. The more collateral you can post, the more sensible the debt. Today’s household assets are $68 trillion, even after the loss of $7 trillion in the value of homes (Fed Z-1, B.100), versus total liabilities of $14 trillion. A $54 trillion net worth ain’t bad. Household assets — wealth — have far out-paced the growth of debt: total household assets in 1980 were $14 trillion, which inflation has doubled, but total 30-year growth has been 457%.

We’ll soon have $10 trillion in Treasury debt, plus $14 trillion owed by households, and another $10 trillion in state, local, and business debt, but how do we get to this terrifying $55 trillion? Have to add a mountain of financial-market paper, almost all self-carrying and self-canceling versus financial assets.

Treasury debt is dangerous because of its permanent call on tax revenue to pay interest, crowding out other spending, necessary and not. Household debt tends to extinguish itself: into middle age we add assets and debt, and on the way to Happy Acres we downsize and reverse the process.

While the mob has us in this deleveraging choke-hold, the economy cannot grow out of debt, and prudently leveraged assets are falling in value. The mob responds: we must raise our savings rate! Clients say to me, “Save? From what? My family is break-even after cutting all that we can.” And the unemployed are notoriously poor savers.

The worst of deleveraging dogma is the absence of end game: How much debt are we supposed to pay down, while not taking on any new? What is the target, and why? How will we know when we’re done? How to get from here to there in a flat economy?

No answer. None at all. Self-imposed dead end.

One line in Perfesser Bernanke’s testimony dominated the week, but in an odd way: it was an anti-forecast. “Uncertainty about the outlook for growth and unemployment… greater than normal….”

The stock market took it as good news (in that NeverNever Land, the only uncertainty is how high it will go), but bond and mortgage people took it the other way, the 10-year T-note briefly 2.88% (a fifteen-month low), mortgages still near 4.50%.

Fed policy is established by six governors appointed by the President and confirmed by Congress, and six of the presidents of twelve regional Feds (voting rotates). The appointed governors tend to be a sharp lot; the regional presidents are an uneven mix of able people and narrow, pinched, country bankers — hard money types who think people should be punished for their mistakes. Several times for each one.

In these deliberations, prediction is power. In two ways: all central banks battle “policy lag,” the six to eighteen months it takes for Fed action to bring full result on an economy that by then may look a hell of a lot different than it did when the action seemed appropriate. Policy lag forces the Fed to pre-emptive measures, trying to get in front of events already taken place. Second: voting governors and Fed staff cannot float ideas just because they sound cool — policy must have solid foundation in the econometric computer models assembled and tweaked in the last 50 years.

Since July 2007, these models might as well have been spittoons. From the onset of unprecedented bank-on-bank wholesale run all the way to the Lehman domino in September 2008, the Fed was behind, sticking to traditional rate cuts and liquidity.

The Fed understood the Lehman disaster, and in the following winter mostly on its own stopped the run by effectively guaranteeing every deposit and liability in the financial system. By March 2009, running against the Fed was silly, and so it stopped.

Since then, many have taken credit for preventing a new depression, the Obama stimulus and bank stress tests in the lead. The stimulus was worth trying, and the tests more sham than substance — the Fed had already done the prevention.

Since spring 2009, the Fed and Administration war on recession has been sitzkrieg. The duds at the Fed are worried that it is too easy, inflation ahead. The enlightened cannot say the duds are wrong: all of the models promise that monetary ease and rates like these will bring recovery. In the last three months the economy has been in obvious slowdown. However, nobody knows if this is a blip or a double-dip, or if a real recovery is underway, or if we’ve entered a flat New Normal stabilizing unevenly.

Of all components of the economy, housing is the one most out of whack. MGIC, the mortgage insurer, on July 1 released its new market-conditions guidance. It rates the 73 biggest metro areas “strong, stable, soft, or weak,” and a similar scale for trend. Of the 73 not one is strong, and only 27 are stable; all the rest soft or weak (24 weak). Of the stable 27, twelve are softening. Of all 73, three are rated “improving” — my backyard, Denver, from soft; Washington DC likewise; and Santa Anna CA from weak.

To illustrate the dud-sharpie divide at the Fed (and elsewhere), and frozen policy, consider Richmond Fed Prez Jeffrey Lacker, in July: “Housing is such a small portion of the economy now, it’s a little less capable of doing damage.”

As wrong as I think these people are, it is possible that one day soon a frightened soul will creep from her bunker for a quick recon outside. Markets always ignite by accident, and often when everyone knows they can’t. All it takes is enough people yelling back down to bunkers, “Hey, Harry! That house you’ve been talking about for ten years… a loan for three hundred grand only costs $1,500 a month! Get outta there. While you’re at it, get some sun.”

I have no idea how close we are to that blessed moment, and the general economic ignition that would quickly follow, but I do know that it’s housing first, then consumer spending and sales volume, and then jobs.

In the last ten days, stocks had improved and interest rates risen during a general relaxation of panic — which has not renewed, but unmistakable evidence of faltering recovery has pushed a lot of money back to the safety of bonds, and rates are again near all-time lows. Thus panic morphs quietly to resignation.

Something odd happened to the economy in May, but it is not clear what. All of the  data arriving for several weeks has had the same pattern: weaker than prior report, and below reduced forecast. June retail sales were supposed to slide .2%, but arrived minus .5%; The NY Fed’s July index was expected at 18, down from June’s 19.57, and came in at 5.08; the Philly Fed index, forecast at 8.0, down from 10.0, landed at 5.0.

The NFIB small-business SBET (www.nfib.com) coughed up three months of gains, back into deep recession. Purchase-mortgage applications fell again, down 3.1%, 44% below April levels despite mortgage rates near 4.50%.

The Fed released the minutes of its June 22-23 meeting, which cut its forecast for GDP growth by .2% to a 3.0-3.5% range for the whole year. Ain’t gonna happen. The new-data string above has already fallen out from under the Fed’s June thinking. 1^st quarter GDP grew 2.7% annualized, and may turn out to be the best quarter of 2010.

Some thought the BP well cap might bring some joy to markets. It did not, and should not. The total spill, 86 days at maybe 50,000 barrels per day, is equal to the oil-product burned in American cars and trucks… in half of one average day.

In bizarre, uniquely American good news, the FinReg bill is a fine legislative accomplishment. Oh, it’s 2,300 pages of sand in the gears and bureaucratic bloat, but when you consider the damage it could have inflicted… well done, Congress.

Months of haggling defused dozens of energetic and dangerous proposals from Left and Right. In a triumph of democracy, the bill reflects the state of mind of the people: collectively, civilians still have no idea what happened to cause the Great Predicament, and so Congress felt little pressure to do much of anything in particular, and didn’t.

Instead it did one thing very well: it has ratified the emergency actions of the Fed and Treasury ’07-’09 by granting general powers to intervene as they did, adding  explicit clout to fold up failing giants, and established a systemic watchdog. However, Congress avoided thou-shalt specifics (such-and-such ratio, or bust up so-and-so) in favor of a flexible command authority: Thou Shalt Use Thy Head.

Have no doubt that this generation of regulators will use the powers granted, just as their granddaddies did from the 1930s until their kids gradually forgot in the 1980s. Good thing, too. Despite renewed vigilance, it won’t be long before the next financial predicament. In all the recent praise for the genuinely fine public servant, Paul Volcker, do not forget that his watch included the S&L catastrophe and the first pack of imperial bankers making immensely stupid loans with petrodollars.

By now, no one should have faith in capital, moral hazard, Mr. Market, skin-in-the-game, Volcker Rule, or size reduction to prevent future episodes. Credit is too slippery.

In good times, even cautious lenders cannot fully know the asset-market impact of their own and their competitors’ prudent loans. Asset markets tend to continue to rise after they’ve risen because they look safer to lenders and draw more credit. In that upward-spiraling, imprudent lenders always enter, but prudent lenders can rightly say (as I did 2003-2004, to my eternal regret), “I’m not making risky loans, they are.” Levered assets have no inherent value beyond the prices buyers will pay, and will continue to inflate, indifferent to prudence and folly until all are fools.

We can aspire to vigilant regulators with itchy trigger fingers, to whom this FinReg has given authority to match responsibility. We can expect them to moderate the pace of innovation, not prevent it. And we can hope that they will occasionally find a deserving miscreant, and shoot him as an example to the others.

But we should never, ever expect to suspend the credit cycle.

Mortgage interest rates improved this past week as economic data was mostly weaker than expected.  June Retail Sales fell 0.5% on expectations that sales would fall by 0.2%.  Excluding automobiles, sales fell by 0.1% on expectations that they would be unchanged.  The July New York Fed Empire State Manufacturing Index along with the July Philadelphia Fed Business Index were much weaker than expected.  Today’s University of Michigan Consumer Sentiment Index fell to 66.5, an 11 month low.  Also of note, inflation continues to be low.  The June Consumer Price Index (CPI) fell 0.1% on expectations that it would be unchanged.  Year over year CPI is up 1.1%.  June Core CPI, excluding the food and energy components, increased 0.2% on expectations that it would increase 0.1%.  Year over year, though, core CPI increased just 0.9%, the smallest increase since 1966.

The national and local economies have two distinctly separate conditions: 1) Big business (think S&P500) is doing fairly well. Has access to credit, has stopped cost-cutting. IT and health care sectors okay also. However, no meaningful increase in sales. 2) Small business, the nation’s biggest job-generator, still in deep recession.

The greatest strength in the Colorado economy is population growth, especially in-bound net migration. 100% correlation with housing market. People move here for the quality of life, and then find work.

Colorado home-price history shows no bubble, prices about even with inflation since 2002. Periods of flat prices this long have been rare, and tend to be followed by 2-4 years of strong appreciation. Compare soggy 1983-1990 to price spurt 1991-1994.

Although we had no bubble, we did have a large housing overbuild 2002-2006. We have mostly foreclosed our way through that excess supply, and since 2006 are in deficit versus population growth, metro new construction down 85% or more.

Colorado led the nation in foreclosures by 2004, by then beginning to wash out the overbuild, and since washing out the suicidal mortgage products. A normal rate of foreclosure filings is in the .5% annual range; the Metro area has been above 1% since 2002 and in 2008-10 has been stable between 4%-5% of households; early in 2009 recession effects took over as the primary cause from overbuild and bad mortgages. Completed foreclosures have run at half that rate.

As painful as it seems in places on the Front Range, CO housing is the 4th-BEST performer of all the 50 states. Boulder County as a whole lost 2.28% of value in the year ending 3/31/10, but ranked 50th best out of 371 national MSAs, and the loss in value was concentrated in the northeast and mountain portions of the County.

FORECAST

Timing is completely dependent on this partial and slow-motion national recovery, but Colorado housing should recover with the few non-Bubble areas far in advance of the rest of the nation. Further, the recovery here should benefit greatly from the low interest rates necessary to help the majority of the country to recover, and the scarcity of new construction until the banking system loosens — perhaps farther off than recovery itself.

As of June applications, Fannie requires a fresh credit report run ON closing day, and has re-emphasized a few other requirements….

1. Until closing, please do not apply for new credit, or make any significant credit purchase, or engage in a new lease, or add a large amount to a credit card.

2. Please… Do not attempt to check your credit or allow anyone else to, or dispute or close any credit account.

3. Do not move money from one account to another until rehearsed with a loan officer, and be prepared to paper-trail any deposit as large or larger than a paycheck if made any time in the last 60 days.

4. Do not attempt to consolidate debt.

5. Do not change jobs.

6. After closing, some investigation may be made (in-person visit, phone, data-mining…) to verify that you have actually moved into your home within the 30-day grace period.

7. Consider delays created by specialized or multi-layer underwriting.

Last week brought a gale of game-changing news, contradicting recovery, and a whiff of panic. This holiday-short week was news-thin, and mid-July marks the beginning of an often sleepy season for markets and the economy.

Panic is sometimes an excellent investment strategy, but it is a difficult frame of mind to maintain. Thus stocks soared 450 points in three days this week, shorts covering, but bond and mortgage yields held extraordinary lows, underlying worry entrenched. The 10-year T-note rose to 3.05% from 2.95% (mostly pricing down in advance of next week’s $69 billion Treasury bond sale), but mortgages stayed put in the mid-fours.

The economic data that did arrive confirmed a slipping recovery, but not a double-dip. The ISM service-sector report for June followed last week’s pattern: softer than prior month, and well below forecast (May 55.4, forecast 55.0, actual 53.8). New claims for unemployment insurance came down 21,000 last week to 454,000, but have been stuck in that range all year long.

Mortgage refi applications have begun to rise, but purchase ones fell again, by 2% last week, now 42% below the end of April. There isn’t any way to know for sure, but that decline seems far greater than could be explained by the end of the tax credits and  pull-forward of demand. More likely: the tax credits masked an ongoing housing slide.

The most troublesome report was consumer credit: May outstandings dumped $9.1 billion, and the $1 billion gain initially reported for March-April was revised to a $14.9 contraction. A debate of sorts continues: bankers and you-deserve-it analysts insist that credit is shrinking because few will apply, and those who do are poor credits.

As this episode grinds on, there is no question that many people who would have borrowed two years ago, or last year, to buy something or to invest are now too concerned to do anything. And there are many others whose creditworthiness has weakened since the show stopped in 2007. However, try to tell anyone out here on a real-world sidewalk that credit is not tighter than any time in their lives, and tightening, and they’ll laugh at you.

Consider the newest Fannie/Freddie loan data. These GSEs and the FHA are under terrible pressure to stop lending, exerted by factions that have forever hated them (no-government types, most in the financial markets, all bankers, this’ll-teach-yas…). The foolishness of 2002-2006 should never be repeated. However, in 2007 55% of GSE mortgages went to applicants with 720+ credit scores; in 2009, 85%. In 2007, 76% of applicants put down 20% or more; in 2009, 89%.

Those changes are not market movements; those are throughputs of requirements. It is one thing to be cautious. But to re-calibrate standards to tighter than ever before (‘90s, ‘80s, ‘70s…), that is credit starvation, and makes housing recovery impossible.

Another issue: we are in the process of reducing the rate of home-ownership from roughly 69% of households back to something sensible, under 65%. The arithmetic alone demands a new investor-buyer for each home conversion from owner to non-owner (or wait for 15 years’ growth in new households). In 2009, GSE loans to would-be landlords were only two percent of total production. And people wonder why Mr. Market cannot absorb inventory, troubled or not, no matter how far prices fall.

We do not have deflation in general prices, but we are years into asset deflation and its very peculiar effects. Interest rates go to record lows, but purchasing power and theoretical affordability are cancelled by lender panic. Furious attempts to de-lever increase leverage, as assets fall in value faster than borrowers can pay down loans.

It may be good national policy, supported by consensus, to reduce resources allocated to housing. We may also decide to live with less credit than any time since WWII. However, to attempt such strategic change in the belly of this recession is a failure of observation, public policy, regulation, and imagination.

Mortgage interest rates were mostly flat on the week with little economic data for the markets to digest.  Of note, the June ISM Services Sector Index came in at 53.8, weaker than the 55 expected.  Weekly jobless claims fell be 21k on expectations that they would fall by 12k.  May Consumer Credit fell by $9.1 billion on expectations that it would fall by $3.1 billion.  April Consumer Credit was revised lower.  April Consumer Credit fell by $14.9 billion from the originally reported increase of $1 billion.  Both numbers indicate that consumer spending is soft.  May Wholesale inventories increased 0.5%, in line with expectations.  Also, the Treasury announced that it will auction $69 billion in debt next week.

Year-to-year comparisons for the 2nd quarter, 2009 vs. 2010. Source: BARA

Mortgage interest rates improved slightly on the week on generally weaker than expected economic data.  Today’s employment report for June showed Non-Farm Payroll losses of 125k on expectations that payrolls would fall by 100k.  Most of the job losses were driven by the cut of 225k temporary census workers.  The private sector added 83k jobs, lower than the 112k expected.  June average hourly earnings fell by 0.1%, its first decline in several months.  Other economic data weaker than expected included June Consumer Confidence, the ADP Private Job Estimate for June, the Chicago Purchasing Managers Index, weekly jobless claims, the June ISM Manufacturing Index, and May Pending Home Sales.  May Pending Home Sales fell by 30% on expectations that sales would be down 12.5%.  Year over year sales are down 16%.  May Personal Income and Spending were in line with expectations.

The Dow Jones Industrial Average is currently at 9,650, down almost 500 points on the week.  Crude oil futures are currently trading at just over $72 per barrel, down about $7 per barrel on the week.  The Dollar has weakened versus the Euro and Yen on the week.  Also, the 10-Year Treasury is currently yielding 2.952%.

Next week look toward Tuesday’s ISM Services Sector Index and Thursday’s weekly jobless claims as potential market moving events.  All markets are closed on Monday for Independence Day.