And Another Rate Cut

Yes, he did it again. Bernanke cut the Fed Funds Rate by fifty basis points, bringing the benchmark rate to 3%. Now that the price of credit is officially below inflation, could the economy finally recover? I don’t think so. Although I’ve read some analyst opinions that some – very, very slim – chances exist that the Fed’s policy will succeed, the reality is that too many problems in the financial and housing sectors need to be solved. Home prices are more than 30% higher than they should be by historic standards, with California median prices 60% above the reasonable level. Until those come down, and that will be a slow, painful process for many a household, bank, lender, and investor, the Real Estate market will not begin to operate properly. With all the mortgages that are about to fail will come huge writedowns and losses at banks all over the world, slowing U.S. economy, higher rates of inflation and unemployment, and all the doom and gloom that those bring along. I don’t really see how changing the interest rate can warp the reality and all the inevitable processes that are slowly unwinding, but the Fed has a job to do, and they’re doing their best. Who knows, it might just work. And by the way, I’m not really keeping score but isn’t it funny how for three meetings in a row, there’s always one – and only one – member of the Fed that votes against a decision. It’s always a different person but I’m beginning to feel there’s a reason why they appoint someone to disagree with the majority. Perhaps it would “scare the markets” if everyone voted for the rate cut? Well… I think they’re quite spooked already; could it really get any worse?

The Fed Panicked

A 0.75% rate cut - both the discount rate and the Fed Funds rate. 1 week before a scheduled Fed meeting. This is huge. A cut like this would be remarkable even at a normal meeting, but Bernanke chose to slash rates at an emergency meeting. He must have been really scared about the stock market and the economic prospects if he couldn't wait for another week. This feels disappointing. The last time the Fed slashed rates at an unscheduled meeting was after the terrorist attacks of Sept. 11, 2001. It's just plain wrong to go this far, Bernanke is sending the wrong signals and tinkering with economic fundamentals that will greatly impact businesses and the lives of individual consumers. Well, at least those who wanted a 1% cut will be happy - the Fed will meet on Jan. 30 and it might cut some more then. For the time being, happy 3.5% Fed Funds Rate.

Bush Administration Proposes Fiscal Stimulus

On Friday, Bernanke and the Bush administration proposed a “fiscal stimulus package” of $150 billion to help prop up the economy by encouraging consumer spending. No details were available, because the Congress has yet to approve it, but the administration is considering one-time tax rebates of approx. $800 for all consumers. An agreement will probably be reached in 30 to 45 days, just in time for tax-filing season. The plan is costly, and there’s some doubt that it won’t help the economy in the long term. Although it actually provides consumers with free cash, no one knows how they may react: in the current crisis, people are unlikely to start spending more. They may have to pay down credit card debt, buy insurance, or choose to invest the money. It may offer some relief, but it will not solve all the problems in the U.S. economy. Stock markets were closed on Monday, but Dow Jones and S&P 500 futures prices dropped more than 4% in a day. Markets all over Europe, South America, and Asia plunged on worries over bank losses, the U.S. Real Estate market and an imminent recession. Now this is getting scary.

Little Optimism For 2008

This is the first post for this year. 2007 was tough, and a lot has changed since last January. Many believe the housing and capital markets may never be the same again. There’s hope for improvement later this year, and yet there’s some fear that things may get worse before they get better. November housing data, released at the end of December, gives little reason for optimism. New-home sales dropped 34.4% on year-over-year basis, the largest drop since 1991. The median price was down 0.4% on a yearly basis to $239,100. This number doesn’t account for builder incentives, which means that the actual prices have dropped even more. Sales of existing homes were up 0.4% compared to the month before for the first time since February – this sounds like a piece of good news but it’s hard to classify it as a turnaround point. Fewer homes were sold in November than the previous month: 46,000 homes sold compared to 55,000 in October. The supply of unsold homes currently on the market would take 10 months to sell at the current pace.

Mortgage interest rates ended the year nearly where they started, with the 30-year fixed-rate mortgage averaging a little above 6.1%. This, however, happened after interest rates topped 6.7% in the summer and the Fed lowered its benchmark interest rate by 1% with three consecutive rate cuts. Forecasts for 2008 range from extremely bearish to modestly bullish, but most are pretty cautious and somewhat vague. Happy New Year and let’s hope it’s a good year.

Another Fed Rate Cut

The Fed cut its benchmark interest rate again, by 0.25% to 4.25%. The discount rate was lowered accordingly to 4.75%. Economists who had expected a half-point cut in the Fed Funds Rate were disappointed, as recent bad news was expected to prompt more aggressive action by the Federal Open Market Committee (FOMC). The Dow Industrials dropped nearly 300 points after the cut. Stocks of mortgage lenders and large banks suffered, including those of Countrywide Financial, Wells Fargo, Fannie Mae, Freddie Mac, Morgan Stanley, Merrill Lynch, Goldman Sachs and others. Shares of home builders Pulte Homes, Toll Brothers, Lennar and Beazer took a hit as well. The Fed’s statement suggested that they’re worried about the economic slowdown and lower consumer spending, while “some inflation risks remain” too. Meanwhile, holiday shopping has slowed down, and the holiday season’s start wasn’t that impressive after all. Analysts believe the Fed may cut again in January if holiday shopping data is weak and the financial markets remain in freeze mode.

As The Year Ends

2007 is drawing to its end, and between holiday shopping and baking cookies, some are trying to analyze the housing market trends and forecast its future behavior. While predictions range from mildly gloomy to disastrous, the NAR produced an amusingly optimistic home sales forecast for 2008. After reducing their home sales forecasts for 9 straight months, they now revised their 2007 forecast upwards, to 5.67 million from 5.66 million. Chief economist Lawrence Yun said an optimistic job market report and the government’s help for troubled homeowners influenced the improved outlook. The group believes home sales will rise to 5.7 million in 2008. A Global Insight economist forecasts 4.7 million home sales in 2008.

Merrill Lynch predicts a gloomy 2008 for the U.S. economy with high energy prices, weak employment, tight credit and falling home prices. And by the way, Fannie Mae and Freddie Mac are introducing tougher requirements for mortgages they securitize.

Citigroup’s Chief Economist Forecasts Large Rate Cuts

Lewis Alexander, Citigroup’s chief economist, said he expects the Fed Funds rate to drop 1 percentage point by mid-2008. He believes the Fed will not be concerned about the dollar’s stability because the currency’s value doesn’t affect consumer prices. Alexander, who’s worked at the Fed before joining Citi, is also optimistic about oil prices and the housing market, and believes the U.S. will not go into recession.

All of this is highly debatable, given all the evidence to the contrary we’ve seen so far. Recession is probably around the corner, or already beginning in some local markets, and the dollar’s weakness does affect the prices of imported goods. While a weak dollar benefits the GDP and the job market, its advantages do not offset all the trouble it causes. While a 3.5% Fed Funds rate is not impossible, a great many companies and financial structures will need go under before the Fed cuts this deep. They’ve seen what happened the last time they cut interest rates too low, and they’ll probably look for other ways to prop up the economy. Alexander said energy prices are unlikely to rise from now on, but should the Fed cut, as it is expected to, on Dec.11, oil may well skyrocket beyond $100/barrel, despite the recent drop in prices. Perhaps Alexander is being optimistic, or perhaps he knows something most of us don’t. However, we’ve already seen too many top economists denying the obvious to believe in things the just seem illogical.

Home Prices Dropped 4.5% In 3Q

According to the S&P/Case-Shiller index, housing prices dropped 4.5% year-over-year in 3Q, the sharpest drop since 1987 when S&P started tracking the data. The index also scored another record – the largest quarter-to-quarter decline, with a drop of 1.7% from Q2. Falling home prices will cause more borrowers to become “upside down” in their homes, meaning they owe more on their mortgages than their houses are worth. After tremendous writedowns on mortgage-backed securities, investors and financial institutions have lost their appetite for risky assets and, according to some publications, credit availability is so low that another crunch similar to the one observed back in August is possible. Opinions, however, vary, and some Fed members even believe a rate hike would be good for the economy, while Wall Street is almost certain that there will be a rate cut in December. I tend to believe that, in this chaotic situation, the Fed is very much likely to reluctantly cut rates another 0.25% to prevent further tightening of credit. They don’t like to be pressured but they will have to take expert opinions into consideration.

Charles Schumer Concerned Over FHLB Lending To Countrywide

After a news story in the Wall Street Journal detailing Countrywide’s increased borrowing from FHLB, Senator Charles Schumer urged the Federal Housing Finance Board to probe the funding. The Federal Home Loan Bank of Atlanta [FHLB] has extended more than $50 billion to Countrywide Financial, and Schumer is concerned that the collateral the loan is secured against is somewhat shaky. The advances made to Countrywide make up 37% of the bank’s total outstanding loans, which makes Countrywide its largest borrower. Schumer considers FHLB’s exposure to Countrywide “an unreasonable risk”, because of the lender’s current weakness. However, FHLB said in a September SEC filing that its exposure to subprime is “minimal”. According to the Wall Street Journal, Countrywide has secured the $51 billion in advances with $62 billion in collateral. Shares of Countrywide dropped more than 10% to $8.64 on Monday.

Freddie Mac Seeks To Raise Capital

Freddie Mac was all over the headlines this morning, as recent news revealed the mortgage giant’s weaknesses. It is believed that the company may have insufficient capital to cover potential home-loan losses and there’s talk that both GSEs may be insolvent at some point in the near future, should more mortgages go bad. Moody’s and Standard & Poor’s downgraded Freddie’s outlook to “negative” from “stable”, though its debt is still rated AAA. Fannie and Freddie are required to hold 30% more capital than the minimum for other companies, and Freddie Mac found itself short of money, so it is now issuing securities to raise capital. Currently the company has $600 million above the minimum reserve level, much less than its $1-2 billion comfort level. It revealed plans to sell $5 billion of preferred stock in the very near term, probably this week. If losses in the fourth quarter are comparable to those in the previous three months, the mortgage giant will need to raise even more capital. James Lockhart, the director of Fannie Mae and Freddie Mac’s regulator, OFHEO (Office of Federal Housing Enterprise Oversight), refused to suspend the extra capital requirement when asked to.

Dollar In Freefall

The dollar hit yet another record low against the Canadian dollar, which traded at $1.1040. This is the lowest rate since 1950. The Greenback fell against other currencies as well, and quite significantly. It hit a 26-year low against the pound at $2.1052, and a 23-year low against the Australian dollar, which was priced at nearly $0.94. The Euro traded at $1.47 yesterday, the highest since the inception of the 13-nation currency.

China announced that it will diversify its foreign exchange reserves, which may further weaken the dollar. Chinese officials no longer regard the dollar a “world currency”, according to Xu Jian, a central bank director. Analysts believe that further weakening of the dollar is likely, although some indices would suggest a bottoming out of the dollar’s freefall.

The dollar’s weakness pushed crude oil prices higher to a new record of $98/barrel, while gold reached a 27-year high. Good news for anyone trading in those commodities and for export companies. Add to this the facts that the economy isn’t exactly booming and troubles in the Real Estate market are far from over. And one of these days someone may officially call a recession. The world is changing…

Credit panic and foreclosure bailouts

Brilliant “bright” ideas on how to prevent a looming financial crisis are raining from everywhere. Just in the past few days, the following proposals have been all over the news.

PIMCO’s Bill Gross urged the White House to bail out troubled home owners: “If we can bail out Chrysler, why can’t we support the American homeowner?” I would say that the Chrysler bailout wasn’t a very good idea either, but then the government had its own reasons for it. In my opinion, it would be totally unfair to pay for borrowers’ unsound financial decisions with other taxpayers’ money. According to this blog entry, it turns out Mr. Gross himself is heavily invested in mortgages and further foreclosures would sting him quite badly. So that’s why we need to bail out borrowers.

Another brilliant plan comes from presidential candidate Senator Christopher Dodd (D-Conn). What he suggests is, to allow the Federal Housing Administration (a.k.a. FHA) to refinance troubled loans. He believes that the FHA does not serve its purpose well and needs to be reformed is order to be able to help homeowners-to-be. Dodd suddenly appeared among those “concerned” about housing several months ago, and started criticizing the government and the existing system, proposing some rather dubious solutions. Dodd also supported the idea to lift the investment caps on Fannie Mae and Freddie Mac’s portfolio, a move that would allow an inflow of financing on the market. The idea was rejected.

I really wish all these activists were this creative a couple of years ago and invented an economically sound way of “saving the economy”. Unfortunately, right now we are indeed facing serious problems that need to be solved, and every solution seems to have “unwanted side effects” for the economy, the dollar, or the average consumer. Every foreclosure is a particular family’s tragedy, but many of the loans defaulting now should have never been made, and those who were involved in the process only have themselves to blame. It is true that the entire business was infested with fraudulent activity, but in the end everyone had a choice. Sadly, greed often prevailed.

Meanwhile, the Fed has some “bright” ideas of its own. According to CNN Money.com, the central bank has temporarily exempted Citigroup and Bank of America from limitations on the amount of money they can lend. So this is more of the same – a move to artificially boost cash flow in a market that is essentially stagnant. Sounds good for a short-term solution, but in the end market forces should be allowed to play their part in the whole thing.

The Fed to meet at the end of January

With the Fed meeting on Jan 30-31st, next week may prove to be an interesting time for investors and mortgage brokers. The last Fed meeting in December 2006 brought no rate adjustment, but the policy statement implied a possibility for further increase. Nevertheless, economists deem hikes unlikely, after four consecutive meetings since August 2006 without a rate change. Predictions are that the rate will remain unchanged after the meeting yet again, and a cut is possible later in 2007.

The mortgage and sales data to be received until the end of this week will be very important, as it will outline the current direction of the market, which shows some signs of decline in activity. This may or may not affect the overall picture but it may influence the outcome of the meeting.

In the meantime, on Tuesday, January 30, 2007, Patricia Cook, Freddie Mac’s executive vice president of investments and capital markets, will hold a speech at the Citigroup 2007 Financial Services Conference in New York City.

The speech will be broadcasted live through a link on Freddie Mac’s webpage http://www.freddiemac.com/investors. The archive will be up early on January 31st and available until March 1st, 2007.