Commentary: No end in sight to credit starvation
By Lou Barnes, Friday, August 22, 2008.
Mortgage rates bottomed again at 6.5 percent, as they have since May, maintaining a consistently wide spread to the 10-year T-note, which bottomed at 3.8 percent. It will take a substantial negative economic event or news to break below these rates.
Economic data were thin. The July index of leading indicators fell hard, the outsize 0.7 percent drop entirely due to rising claims for unemployment benefits and a big slide in building permits. July housing starts dumped another 11 percent, surprising the remarkable number of people still with faith in a housing bottom nearby -- rather like finding pigeons who want to bet 10 bucks on an instant replay.
The last weeks of summer are poorly attended in the markets, movements meaning little. The world's central bankers are now convened in Jackson Hole, reports indicating a consensus forming around hope and the hazards of action. The shooting will start again immediately after Labor Day with fresh data from August, especially payrolls.
The big news right now is the Fannie-Freddie deathwatch. First thing: Borrowers should relax; the consequences of demise for you will be either good news or no news.
The pending takeover is in many ways a non-story, just confirmation that Fannie and Freddie were, indeed, too big to fail. Hopes will be dashed at the Fed and Congress that takeover will benefit our decapitalized financial system and the economy. Maybe, just maybe, the authorities will absorb that lesson, and begin useful action.
Secretary Henry Paulson demanded total takeover power in July, telling Congress that if he had such power he would not have to use it. Wrong again, Hank. Holders of $5 trillion in F&F paper immediately wanted to be Treasury-guaranteed, and any possible sources of new capital instantly vanished. Invest, to be wiped out in takeover?
Paulson's new problems: whom else to wipe out in an F&F takeover. Common stockholders are already gone. Holders of bonds have to be made good, as the $1.4 trillion worth is a key asset in institutions all over the world. Preferred stock? Same deal. The cutoff decision will be precedent for the bank failures to come: Who, exactly, is TBTF (too big to fail), and when one tanks, who gets paid?
The very good news: Current Fannie and Freddie management and regulators, captains of malfeasance, will be excused. Historical error aside, these people have been busy in the last six months undermining their sole purpose. Every loan now suffers a 0.5 percent fee surcharge. Since winter, every borrower with a credit score under 720 has suffered a surcharge; unless cancelled, that bar will rise to 740 on Nov. 1. The list of loans ineligible for F&F assistance is now longer than the one of still-doables.
The no-news is disappointing, but real: Takeover will not improve mortgage rates. Maybe a little, if the surcharges are removed. In the market's eye for credit, there is little difference between the presumption of too-big-to-fail and the fact.
But, won't F&F be able to buy loans again, and push rates down? For housing to bottom, we must have lower rates and better availability, right?
Right on the second point, wrong on the first. There are $5 trillion in GSE mortgage-backed securities out there, and F&F own only $1.4 trillion. The principal owners of the other $3.6 trillion are giant institutions in desperate trouble. If anybody began to bid aggressively for MBS, trying to drive price up and yield down, those owners would dump their massive holdings in the same market mechanism holding rates up where they are. Any slide to 6.5 percent, and they elbow new borrowers out of the way. Neither F&F nor the U.S. Treasury could possibly borrow enough money to buy them out.
Maybe, just maybe, the authorities will get the following equation. Normal MBS holdings are maintained with leverage of capital. With capital mostly gone, every big outfit is trying to reduce leverage. So, rates have to be high to attract unleveraged buyers: mutual funds and such. The only way to restore leveraged buyers is to restore capital by federal injection and/or accounting mirrors. Until the authorities make that leap, the real economy will deteriorate in gradual credit starvation.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at email@example.com.