Why Did So Few People Save For Hard Times?

February 4, 2009 by admin Leave a Comment

Consumers usually build savings in booms, then raid their troves during busts – but not this time.

In booms we put away some of the abundance because we know we’ll need it in busts to come. Then, when the bad times hit, we spend some of what we’ve saved. But no more: Our recent bizarre behavior helps explain how we got into this economic mess.

For the first time since Genesis, consumers are doing everything backward. During the expansion from 2002 through 2007, our savings rate fell rather than rose. In mid-2005 it even went negative, and it mostly stayed below 1% until late last year. Then, as the recession really took hold, we again did the opposite: We increased our saving. As the economy shrinks, our savings rate has climbed to almost 3%.

Not only do we lack savings to dig into and spend during this downturn, but we’re also spending a smaller proportion of our incomes (which are themselves stagnating, so maybe it’s a triple whammy). Put it all together, and it’s clear why this recession is dragging on.

The central mystery: Why did we go into hock in the fat years? One argument is that we were behaving rationally. As our homes increased in value, they were doing our saving for us, so we didn’t have to save out of current income.

Nor was our borrowing binge focused only on mortgages; we were going heavily into most other types of debt as well. In fact, we were spending record proportions of our incomes just to service our personal debt – even with interest rates near historical lows.

Maybe it was just a mania, focused not on tulip bulbs but on the simple joy of buying, reinforced by a belief that bad times were no longer inevitable.

Whatever happens, don’t expect miracles. Spending and saving behavior evolves slowly, and our current mess is in some ways the culmination of a long journey. We may not suddenly start behaving with biblical wisdom. But at least let’s try not to forget how bad things can be when we get spending and saving backward.

Normal vs. Abnormal

It’s normal human behavior to want more than we have. Our free enterprise system rewards hard workers by allowing them to live well. What was not normal over the past decade were the ridiculous lending policies of the banks, encouraged and supported by the easy monetary policies of the Federal Reserve.

In fact, not much of anything was normal over the past ten years. It’s not normal to lend borrowers large amounts of money without regard to income or credit. It’s not normal to expect housing prices to rise 100% every five years. It’s not normal to expect that a nation could borrow its way to prosperity. The list goes on.

The really bad news here is that while consumers know what they have to do (save more, spend less) every action being taken by the Government and Federal Reserve is to continue the failed policies of the past, this time on an even grander scale. Let’s all hope that the common sense of the governed will ultimately elect leaders who stop promising free lunches with borrowed money.

Courtesy: mwhodges.home.att.net/

Filed Under: Economy, Federal Reserve, Housing, Stimulus Plan Tagged With: debt explosion, Free Lunch, low savings rate

Fannie and Freddie – The New Subprime Lenders

February 2, 2009 by admin Leave a Comment

Fannie and Freddie Impose Huge Fees On Borrowers

Freddie Mac last week announced additional fees for condo owners who refinance, effective April 1, 2009. The fee mirrors a similar charge imposed by Fannie Mae last year. Both Fannie and Freddie now assess a wide variety of fees to borrowers based on loan to value, credit and type of loan. The fees are euphemistically referred to as “Postsettlement Delivery Fees for Mortgages with Special Attributes”. Translation – we need the money and are now charging huge fees to reflect lending risks that we never recognized prior to the housing crash.

Many borrowers are finding out that the Fannie and Freddie fees are resulting in mortgage rates far higher than the rates they see advertised. See All Time Low Rates For A++ Borrowers Only. The fees imposed are too large to be absorbed by the lending institutions that sell their loans to Fannie and Freddie. Therefore the fees must be passed on to the customer in the form of closing costs and/or a much higher interest rate. The total fees imposed by the agency lenders are cumulative for each special attribute. The end result is that the fees and rates are so high that most borrowers are unable to refinance.

Here is an example of the fees that Fannie and Freddie would charge on a routine mortgage refinance with the following “special attributes”. The borrower is attempting to refinance at 80% loan to value, has a 675 FICO score and needs to take cash out. This is a routine type of refinance and the credit score of 675 is considered good. The borrower is applying for the prevailing rate of 5.5%. Three years ago, this borrower would easily have qualified under a conforming Fannie or Freddie loan with a minimum of agency fees. The same borrower today, if approved, would be facing very steep fees as follows in a $250,000 loan example.

Delivery Fees Effective April 1, 2009 Based on 80% Loan to Value

1. 675 FICO score fee 2.50%
2. Cash out fee 1.50%
3. If the property is a Condo add additional fee .75%

The total fees imposed by Fannie or Freddie on this example loan would total 4.75% of the $250,000 loan or $11,875. In addition, there are various lender and legal fees involved in a refinance that could easily total another $2,000. These Fannie and Freddie fees make the defunct sub prime lenders look like good guys.

Rates Are Low – Don’t Bother Applying

In real life, here’s what would happen. The borrower refuses to pay $11,875 in fees to get 5.5%. The lender could not provide that rate in any event since the total of fees involved are so high that they would violate predatory lending rules. The rate cannot be raised enough to absorb all of these fees based on current pricing structures. The best this customer could get would be a rate of around 7.25 and agency fees of $7,000, plus regular closing costs. Several years ago, this customer could have gotten a lower fixed rate with much lower fees from a sub prime lender.

For a borrower to get the “low rates available” today, you usually need to show up with a credit score of 740 and a loan to value of 70% or less. Most borrowers who need to refinance today do not possess this loan profile. While the Fed strives to lower mortgage rates, Fannie and Freddie are effectively telling all but the highest quality borrower to get lost by pricing them out of the market. Compounding this ridiculous situation is that the Federal Housing Administration (FHA) does not charge many of these fees, even at higher loan to values and lower credit scores.

By the way, did I mention that the Government has effectively nationalized the mortgage industry?

Filed Under: Banking Industry, Federal Reserve, Mortgages, refinance Tagged With: delivery fees, Fannie Mae, Freddie Mac, refinance

New Federal Standards For Mortgage Industry Largely Irrelevant

January 26, 2009 by admin Leave a Comment

Obama Plans Fast Action to Tighten Financial Rules

WASHINGTON — The Obama administration plans to move quickly to tighten the nation’s financial regulatory system.

Officials say they will make wide-ranging changes, including stricter federal rules for hedge funds, credit rating agencies and mortgage brokers, and greater oversight of the complex financial instruments that contributed to the economic crisis.

Broad new outlines of the administration’s agenda have begun to emerge in recent interviews with officials, in confirmation proceedings of senior appointees and in a recent report by an international committee led by Paul A. Volcker, a senior member of President Obama’s economic team.

Timothy F. Geithner, the nominee for Treasury secretary, made similar comments in written and oral testimony before the Senate Finance Committee.

Aides said they would propose new federal standards for mortgage brokers who issued many unsuitable loans and are largely regulated by state officials. They are considering proposals to have the S.E.C. become more involved in supervising the underwriting standards of securities that are backed by mortgages.

More Effective Regulation Was Necessary Years Ago

Anyone familiar with the type of mortgage lending that occurred during the housing boom and lending mania should applaud the actions of the Obama administration. Mortgage loans werer granted to all takers, no questions asked. Every party involved in the lending lunacy bears responsibility – this includes the Fed, Congress, Wall Street, major banks, sub prime lenders, and the multitude of mortgage brokers who fed the food chain above them.

The unanswered question is why weren’t these regulations passed and enforced 5 years ago? Apparently, Alan Greenspan’s encouragement to borrow by keeping credit easy and rates low lulled all of us into complacency.

Too Little, Too Late

Enacting legislation now to control the excesses of the mortgage industry is largely for public relations consumption.

Stricter regulations won’t help much now – the disaster has already occurred. The sub prime lenders are out of business, most of the major banks are insolvent, the Wall Street firms are largely bankrupt, borrowers no longer qualify, buyers are too afraid to buy a home and most of the mortgage brokers are out of business. Who is left to be regulated??

The mortgage industry has effectively been nationalized. The only lenders that remain are government owned or sponsored – Fannie Mae, Freddie Mac and the FHA. It’s great to have these new financial regulations but it is largely irrelevant at this point.

Filed Under: Banking Industry, Federal Reserve, Mortgages Tagged With: lending abuses, new federal mortgage regulations

Fed Struggles To Lower Mortgage Rates

January 23, 2009 by admin 1 Comment

Fed Determined To Lower Mortgage Rates With Unconventional Methods

Mortgage rates started dropping late last year after the Federal Reserve announced that it would be purchasing mortgage backed securities (MBS) in an effort to lower mortgage rates. As recently as January 13th, Fed Chairman Bernanke again attempted to talk down mortgage rates in his speech at the London School of Economics by discussing the potential purchase by the Fed of longer dated treasury securities. Bernanke noted that “In determining whether to proceed with such purchases, the committee will focus on their potential to improve conditions in private credit markets, such as mortgage markets.”

Shortly after Bernanke’s London speech, Charles Evans, Chicago Fed Chief, reiterated the Fed’s determination to lower rates by stating that “With the United States in the midst of a serious recession, it could be useful to purchase significant quantities of longer term securities such as agency debt, agency mortgage backed securities and treasury securities. We stand ready to grow our balance sheet even more should conditions warrant. At the current time, the biggest concern is deflation and the Fed can worry about inflation later.”

Given the Fed’s determination to lower mortgage rates, why have mortgage rates jumped 75 basis points over the past week?

Most of the Fed’s current and potential purchases of MSB and long dated treasuries may already be substantially discounted by the market. The larger question is does the Fed have the resources to force mortgage rates lower given the competing demands for funding by virtually every major sector of the economy? Although mortgage rates have declined , they have not dropped to the extent necessary to give homeowners truly significant savings, especially after the recent run up in rates.

The Fed views lower mortgage rates as crucial in stabilizing a collapsing housing market. However, if the Fed could have brought mortgage rates down to 2%, they would have, which implies constraints on their ability to manage rates. These constraints are becoming visible on the Fed’s ballooning balance sheet. The world is discovering that there are limits on the ability of Governments to bail out every sector of the economy. (See Insolvent Banking System Eludes Government Containment.)

Lower mortgage rates may become a sideshow to the larger issue of the solvency of nations, with Britain being the latest example . (Gordon Brown Brings Britain To The Edge Of Bankruptcy) The demands on the British treasury to rescue the entire banking system and economy are so large that the British pound has crashed and the very solvency of Britain is now being questioned. This unfolding financial disaster in Britain puts a serious dent in the theory that Governments have unlimited financial resources. The implications for the US Treasury, by extension, are ominous.

Filed Under: Federal Reserve, Interest Rates, Mortgages, Uncategorized Tagged With: mortgage rates, solvency of nations questioned

Mortgage Rates Surge Upward – Is The Refi Boom Over?

January 23, 2009 by admin Leave a Comment

Mortgage Rates Up Sharply Over Past Week

Mortgage rates increased again today as the sell off in the long treasury market continued. The all time lows in the mid 4% range have quickly disappeared.

A short week ago the best borrower could obtain a par rate of 4.5% – see All Time Low Mortgage Rates. Today that same borrower is looking at a rate of 5.25%. Borrowers who have applied for a refinance and did not lock the rate are in for a payment shock. On a $250,000 loan, the payment increases by $1368 per year on an increase from 4.5% to 5.25%. Higher rates and tougher underwriting standards are beginning to stop the mini refinance boom dead in its tracks.

Despite the large recent increase in mortgage rates, keep in mind that the Federal Reserve is determined to do whatever it takes to bring mortgage rates lower. Whether or not the Fed will succeed in lowering rates is unknown.

Lower Rates Still Possible

Factors that may ultimately bring mortgage rates to 3.5% or lower include the following (See – Is 3.5% Possible?)

The Federal Reserve’s direct purchases of mortgage backed securities initiated late last year was successful in its goal of lowering mortgage rates. The Fed’s direct purchases of MBS has stabilized the mortgage market and lowered rates. There are arguments being put forth that due to the Fed’s intervention, mortgage rates have artificial price support. Nonetheless, if the historical yield spread between the bond and the 30 year mortgage is re-established, we may see a 30 year fixed rate in the 3.5% range. Something to think about for those contemplating a mortgage refinance.

The question of whether the Fed is manipulating mortgage pricing at this point or how long such price support can last is somewhat irrelevant. The major fact to keep in mind is that the Fed appears to be relentless in its campaign to drive down mortgage rates. If the Fed can stabilize the MBS market we may be looking at mortgages rates in a range we never thought possible a short time ago.

30 year fixed rate mortgages in the mid 3% range would cause a huge refinance surge. Keep in mind that over the past five years, homeowners had multiple opportunities to refinance in the low 5% range. Unless the borrower is taking cash out, it usually does not pay to refinance for less than a one percentage point reduction. At 3.5% rates, it would make sense for almost every homeowner with a mortgage to refinance again.

If rates do move into the mid 3% range or lower, the benefits will arguably go to those who need it least. Based on present underwriting standards, those with poor credit, late mortgage payments, no equity or insufficient income need not apply. The sad irony here is that the Fed’s costly efforts to reduce rates may do little to benefit the economy or the majority of homeowners. (See All Time Low Mortgage Rates for A++ Borrowers Only)

Filed Under: Federal Reserve, Interest Rates, Mortgages Tagged With: 3.5% mortgage rate?, mortgage rates surge upward, refi boom over

All Time Low Mortgage Rates For A++ Borrowers Only, Fed’s Efforts Futile

January 15, 2009 by admin 5 Comments

As discussed on December 31, 2008 many homeowners attempting to lower their mortgage rate apply for a refinance, only to discover that they do not qualify for the “low advertised rate” (Few May Benefit From Lower Mortgage Rates).

Unless a borrower has perfect credit (at least a 720 FICO score), adequate income (debt ratio of 32% or less) and substantial equity in the home (loan to value of 75% or less), the rate will be higher due to adders. Adders are fees imposed by Fannie and Freddie if the applicant does not fit into the little box of a perfect borrower. Adders are imposed for higher loan to value, lower credit scores and cash out refinances. The adders can easily amount to 2% of the loan amount, or $2,000 on a $100,000 loan. If a borrower is applying for cash out with a FICO score below 680 many lenders will turn the loan down.

This is the reality of the mortgage market today. Many borrowers applying for a refinance with visions of a 4.875% rate and a payment reduction are finding out that they do not qualify. There is much in the news about the “mortgage refinance boom”. Expect to see stories in a month or two about how few borrowers actually benefited from the lower rates.

The stories of how few borrowers actually benefit from the lower rates did not take long to be noticed.

Rates Fall, But Refinancings Are Limited – Wall Street Journal

Interest rates on fixed-rate mortgage loans for prime borrowers have fallen to below 5%, the lowest level since the 1950s, triggering a wave of mortgage-loan inquiries from borrowers eager to refinance. But lenders and mortgage companies say that as many as half of the people who want to refinance can’t meet the credit hurdles and won’t get approved.

Only about a third of U.S. mortgage debt outstanding is likely to qualify for refinancing, said Doug Duncan, chief economist of Fannie Mae. Nearly 70% of borrowers don’t make the cut, he said, most often because their credit isn’t good enough or they don’t have sufficient home equity. A significant number of homeowners owe more than the current value of their homes, a situation sometimes known as being “under water.” Others can’t profitably refinance, often because they hold jumbo mortgages, those above the $625,000 limit for loans that can be bought or guaranteed by Fannie Mae or Freddie Mac in the highest-cost areas.

Since December 31st when I warned that only the best borrowers would be getting approved, rates have continued to decline. The best borrower can now obtain a par rate of 4.5%. On an after tax basis, mortgage money now costs around 3%. (I remember when savings bonds used to pay 6%.) The good news is that for those who handled their financial affairs properly, the reward is the lowest mortgage rate ever. The bad news is that your home has crashed in value, your stock retirement account is 40% lower and your hard earned savings yield zero interest if you prefer to invest in government treasuries. On my scoreboard, we are all losers here, regardless of lower mortgage rates.

Borrowers Who Take Cash Out On Refinances Are Not Spending The Money

Mortgage refinances being approved show a pronounced borrower preference for frugality. Many borrowers refinancing are doing so only to lower their payments, not to take cash out. Those taking cash are mostly paying off other high rate debt or putting the money into savings. This is not surprising since an A+ borrower does not happen by accident – they are frugal by nature and do not run up large amount of debt for frivolous reasons. Those most inclined to maximize cash out and immediately spend the proceeds are largely no longer qualified for loan approval, either because of income, credit or equity restrictions.

Fed’s Efforts Futile

The Federal Reserve has spent hundreds of billions of taxpayers’ dollars buying mortgage backed securities to artificially suppress mortgage rates. If the Fed’s intention was to spur more debt and spending by consumers, they have largely wasted their time and our money. See Fed’s Asset Purchases Continue To Expand.

Filed Under: Federal Reserve, Interest Rates, refinance Tagged With: All time low of 4.5%, few refi approvals, Mortgage Refinance

30 Year Mortgage Rates At 4.5% – Is 3.5% Possible?

January 12, 2009 by admin 5 Comments

How Low Can Mortgage Rates Get?

According to Freddie Mac, the average 30 year fixed rate mortgage dropped for the 10th consecutive week to a new low of 5.01%. This is the lowest rate reported by Freddie Mac since they began keeping track in 1971.

Rates have moved sharply lower over the past two weeks to all time lows despite the fact that the 10 year treasury bond did not move to new lows. The traditional rate differential between the 10 year treasury and the 30 year fixed rate mortgage has disappeared due to the mortgage crisis and other factors. Risk is now priced higher across all credit markets, including mortgage backed securities (MBS).

Last week, a borrower with excellent credit, necessary income and home equity was able to obtain a par rate of 4.5%. The question of whether the Fed is manipulating mortgage pricing at this point or how long such price support can last is somewhat irrelevant. The major fact to keep in mind is that the Fed appears to be relentless in its campaign to drive down mortgage rates. If the Fed can stabilize the MBS market we may be looking at mortgages rates in a range we never thought possible a short time ago.

Filed Under: Federal Reserve, Mortgages, refinance Tagged With: 3.5% mortgage rate?, 30 year fixed rate mortgage, refinance

Inflation – The Real Long Term Threat To Financial Survival

January 9, 2009 by admin Leave a Comment

Concerned with the preservation of wealth and purchasing power?

The US Government Will Not Choose Deflation
by Rich Toscano and John Simon

Conclusion

We in the United States have been dumping our dollars into the world for years and we continue to do so. We owe a staggering amount of foreign debt denominated in dollars and we are gearing up to borrow even more. Our legislators and the stewards of our currency are rabidly hostile to deflation — they are hostile, in other words, to the idea of the dollar gaining purchasing power. They have shown via word and deed that they will do whatever it takes to prevent deflation from taking hold. When deflation is viewed as even a remote possibility, there are effectively no limits to the amount of money the government can create nor to what they can do with that newly minted money.

Under these circumstances, we just don’t believe that the dollar is going to gain purchasing power in any sustainable way. The current deflationary storm could continue for a while yet, but the longer it goes on, the more violent and severe its reversal is likely to be.

Deflation is a choice within the current monetary regime. It is a choice that our government has shown it will not make. There are serious long-term risks inherent in our dysfunctional monetary system, to be sure — but deflation isn’t one of them.

The writers construct an excellent case in explaining why the government must and will chose inflation. A must read.

Filed Under: Dollars, Federal Reserve Tagged With: Inflation vs Deflation, preservation of wealth

Fed’s Asset Purchases Continue To Expand

January 7, 2009 by admin 1 Comment

The $8 Trillion Dollar Bailout

NEW YORK (CNNMoney.com) — Sitting down? It’s time to tally up the federal government’s bailout tab.

There was $29 billion for Bear Stearns, $345 billion for Citigroup. The Federal Reserve put up $600 billion to guarantee money market deposits and has aggressively driven down interest rates to essentially zero.

The list goes on and on. All told, Congress, the Treasury Department, the Federal Reserve and other agencies have taken dozens of steps to prop up the economy.

Total price tag so far: $7.2 trillion in investment and loans. That puts a lot of taxpayer money at risk. Now comes President-elect Barack Obama’s economic stimulus plan, some details of which were made public on Monday. The tally is getting awfully close to $8 trillion.

The amount of $8 trillion is incomprehensible to most people, including myself. But there is an interesting way to contemplate the amount of $8 trillion dollars. The total amount of home mortgage debt outstanding in 2008 amounted to only $10.6 trillion (see Mortgage Holiday). If the government had simply used the $8 trillion to directly payoff consumers’ mortgage debt, all of us could have seen an 80% reduction in our mortgage payments! Go figure.

Stop the Bankruptcy Cram Down

As Congress debates legislation to empower the Treasury to purchase troubled mortgage-related assets, some are trying to weigh the bill down with ancillary, unnecessary provisions. The one which concerns us the most is a provision that would allow bankruptcy judges to unilaterally change the terms of many mortgage loans, including the loan balance, as part of Chapter 13 bankruptcy proceedings. By granting judges this power, this bill would throw into question the value of the collateral that backs every mortgage made in this country — the home.

The fact remains that the lending community remains united against this idea. It is our position that if this proposal were to become law, mortgage rates would increase by at least one and a half points. In addition, lenders will be forced to require higher down payments and charge higher costs at closing. All these increased costs would be necessary to account for the new risks that lenders will face when judges decide to change how much borrowers owe on their mortgages.

Interest rates are correlated to risk – that’s the way things work in a free market. If a mortgage loan is made with the risk of principal mark downs in bankruptcy, this risk has to be priced into the loan rate.

During the bailout vote, Democratic Senator Dick Durbin of Illinois argued for the right to give bankruptcy judges the ability to change the terms of a mortgage. With the change of power in Washington, the odds of mortgage cram down legislation passing is very high.

Since total mortgage delinquencies are less than 10% and not all of these cases will wind up in bankruptcy, cram downs might help less than 5% of mortgaged homeowners. If the MBA is correct and mortgage rates rise significantly due to cram downs, expect a significant backlash from the other 95% of mortgaged homeowners who will wind up paying for the losses through higher interest rates.

Mortgage/Treasury Spreads Reflect Risk

Bloomberg) — Federal Reserve officials are focused on driving down the spreads between U.S. Treasury yields and consumer and corporate loans, after cutting the main interest rate to almost zero failed to revive lending.

Credit costs for households and businesses haven’t followed yields on government debt lower. Fifteen-year fixed-rate mortgages were at 5.06 percent last week, 2.59 percentage points above 10-year Treasury yields; the spread averaged 0.88 point in 2003, when the Fed slashed rates to 1 percent.

Chairman Ben S. Bernanke sees the thawing of frozen credit markets as critical to a recovery, and is determined to try to prevent a second wave of credit distress as the U.S. weathers bad economic news over the next two quarters. The Fed is now looking at ways to revive lending by using its balance sheet to hold loans and bonds that investors don’t want.

“Investors in general don’t want to take on the risk,” said Richard Schlanger, who helps manage $15 billion in fixed income securities at Pioneer Investments in Boston. “It is going to reach the point where the Fed will intervene again.”

If spreads between treasuries and mortgages followed the historical norm, mortgage rates on both the 15 and 30 year mortgage would be at least 1.5% points lower. The question that is not addressed, of course, is how much higher would mortgage rates be without government price support? Since private buyers see a poor risk/reward ratio in owning mortgages, does the government establish a permanent presence as mortgage lender of last resort?

In addition to providing price support to mortgages, we now have a Federal Reserve pledging to bring down consumer and corporate lending rates as well. The announcement that the Fed would be buying mortgage backed securities brought down mortgage rates. Can the Fed do the same in other debt markets by purchasing securities that free market investors view as too risky to own?

With the Fed extending its purchases into virtually every asset class, a question comes to mind. As the Fed assumes the losses of all the failing economic entities in the country, at what point does the US Government begin to share the credit quality of those they are bailing out?

Filed Under: Bailout, Federal Reserve, Interest Rates Tagged With: Cram downs, Mortgage Holiday, mortgage spreads