Consumer Spending Slowed In October

Growth in consumer spending slowed to the lowest level in 4 months in October, the Commerce Department reported Friday. Spending increased a mere 0.2%, the smallest increase since June. This is slightly below the expected increase of 0.3%. Individual incomes grew by 0.2% as well, which is the slowest pace in 6 months and slower than expected. Gross domestic product increased by 3.9% in Q3, but economists believe the current quarter will not be as robust, with growth possibly slowing to 1% annual rate.

Construction dropped 0.8%, in the 20^th consecutive month of declines for the industry and the biggest decline since July. The slowdown in the housing industry may lead to more layoffs, and even weaker consumer spending. Rising inflation is scaring off consumers and, despite a relatively strong beginning, retailers are bracing for a tough holiday season this year.

Mortgage Rates Lowest In 2 Years

Interest on 30-year fixed-rate mortgages fell to 6.10% this week, the lowest level in 2007, and the lowest since the week of October 13, 2005, said Freddie Mac. 15-year fixed-rate mortgages averaged 5.73%, down from 5.83% last week, which is the lowest since January 2006. I guess now is the perfect time to refinance a mortgage if you can find a lender, but that could be hard, unless you have a perfect credit record. 5-year adjustable-rate mortgages slid to 5.86% from 5.88% last week, not that spectacular but still lower. One-year adjustable mortgages were at 5.43%, up from 5.42% a week ago. Speaking about the housing sector, Freddie Mac’s chief economist Frank Nothaft noted that the “overall picture” looks “glum with no immediate relief in sight”. So it is indeed.

Countrywide and KB Home: the worst not over yet

During a panel discussion hosted by the Milken Institute, Countrywide’s CEO Angelo Mozilo and KB Home’s President Jeffrey Mezger talked about the housing market, the Fed’s policy and surplus inventories. The worst is not over yet, according to Mozilo, and Mezger believes “things are going to stay tough for quite some time” for KB Home. Both agreed that lifting loan limits for “conforming” mortgages would help the industry, because the current limit is below median prices in many areas. Non-conforming loans that cannot be purchased by Fannie Mae and Freddie Mac come at a higher price, which further diminishes affordability and exacerbates problems in the housing sector.

So if they see more trouble ahead, how come Countrywide promised to post profit in Q4?

A Rate Cut Seems Likely

As the next Fed meeting approaches, the likelihood of another rate cut seems pretty high, although some doubts remain. The Government is manifestly not concerned about the dollar, as Treasury Secretary H. Paulson vetoed proposals to use the G7 final statement to warn of problems affecting European economies due to a weak dollar. This may mean that the currency will be allowed to fall further, should the Fed decide to cut rates to boost economic fundamentals.

However, another rate cut could accelerate inflation, and with oil hitting the psychological barrier of $90 a barrel, this could be a serious concern weighing on the Fed’s decision. Housing data for September coming later this week will be important for the Fed’s decision, too. There is no doubt that existing-home sales and new-home sales will fall, the question is whether the drop will exceed expectations, and how the Fed will interpret the data.

Banks suffer amid housing woes

Japan’s largest securities company Nomura Holdings Inc. will post a pretax loss of $620 million, its first quarterly loss in four years, caused by troubled residential mortgage-backed securities. It was also announced that Nomura will cut 400 jobs in the U.S. and shut down its residential mortgage-backed securities business. According to CEO Nobuyuki Koga, “the pace of the collapse” was quicker than expected. Japanese banks Mitsubishi UFJ Financial Group Inc. and Mizuho Financial Group Inc. also reported losses on investments in securities backed by subprime mortgages.

In the U.S., Merrill Lynch and UBS expect to report substantial losses with their third-quarter results, related to home-loan investments. Citigroup revealed a 57% drop in third-quarter profit, including higher-than-expected losses of $1.56 billion on mortgage-backed securities. No wonder that no one wants to originate subprime anymore.

S & P believes housing crisis not over yet

Standard and Poor’s says losses from the housing turmoil will probably peak in 2009, with total defaults reaching $150 billion, although the global economic growth is expected to remain strong for the next two years. The U.S. economy will probably grow at a lower pace due to higher unemployment. S & P’s chief economist David Wyss also mentioned that he expects another rate cut before the end of this year and that the stock market is strong, so financial markets are probably “heading for expansion”.

This estimate, however, may be somewhat optimistic, given the uncertainty reining in financial markets right now and the strongly “bearish” forecasts of some economists. Losses at mortgage lenders are still all over the news, so the mortgage industry is not likely to rebound in the coming months. Jumbo Loan lender Thornburg Mortgage announced yesterday that third-quarter losses on loan sales would be greater than expected, which resulted in an 11% drop in its stock price. Thornburg had expected a loss of $863 million, compared to the actual number it will probably report - $1.1 billion. The estimated loss of the lender’s mortgage securities portfolio was also revised upwards, to $268 million from $262 million. The company believes that it will be able to continue to fund new loans “provided market conditions do not deteriorate further”.

FDIC says, cancel interest-rate adjustments

It sounds a little off to me, but that’s the next brilliant bailout idea: modify loans that are about to adjust and “freeze” the interest rates. This is exactly what FDIC’s (Federal Deposit Insurance Corp) Chairman Sheila Bair asked lenders to do. Naturally, the changes should only affect “good” borrowers who occupy their homes, are current on their payments and own adjustable mortgages that haven’t reset yet.

However, surveys show that only a fraction of the ARMs scheduled to adjust in the coming months get modified, partly because of restrictions in the servicing agreements that limit the number of loans that can be modified. Investors who own the loans are unwilling to allow modifications because this will cause mortgages and the securities backed by them to lose value.

OK, ARMs were designed to adjust at some point, that’s their essence. Converting them to fixed home loans is against the rules – after all, they were marketed as a bet against economic fundamentals and market conditions that affect interest rates. And if a large number of ARMs do somehow get modified, who knows what may happen next? More troubled hedge funds? More credit rating downgrades? Elimination of all types of ARMs? I don’t think this is the solution yet.

More job cuts in housing-related businesses

Forget about steady job growth, several mortgage lenders have announced further staff cuts, and this is no small news. Weaker employment might further curb consumer spending, resulting in a weaker economy altogether.

Lehman Brothers has eliminated 850 positions, as it downsizes in response to tough market conditions. It is closing its Korean mortgage business and renaming all its residential mortgage origination and servicing businesses “Lehman Mortgage Capital”. Countrywide is taking another round of lay offs, eliminating some 900 employees. The last time Countrywide announced job cuts was less than a month ago. Cleveland-based National City said it will lay off 1,300 employees and stop issuing non-conforming loans that can’t be sold to Fannie Mae and Freddie Mac.

A study by Challenger, Gray & Christmas concluded that the 85% surge in layoffs last month was primarily caused by lenders scaling back. Not a very encouraging statistic. In this relation, MarketWatch published a very interesting article about the Fed’s opinion on the current economic conditions. And I thought the guys at the NAR were too optimistic.

Housing starts lowest in 10 years in July

When the housing starts report came out yesterday, no one was surprised that housing starts dropped last month. It is only natural that in a market like the one we’re seeing today builders are unwilling to begin work on new projects. What was surprising is how much they actually declined. Starts dropped 6.1% to an annual rate of 1.381 million, from 1.47 million in June. That is 20.9% below July 2006 levels and lower than the 1.4 million forecast. Permits dropped 2.8% to an annual rate of 1.373, the lowest since late 1996. Builder sentiment is at the lowest level in years, and for good reason: inventories aren’t moving, despite significant price cuts. Although many would like to buy a house, it’s getting harder to find financing and there’s fear that further price declines may drain all equity out of a home.

Mortgage interest rates increased somewhat this week, but they’re still below the highest readings for this year. 30-year mortgages carried an interest of 6.62%, up from 6.59% a week ago. 15-year fixed-rate mortgages were at 6.30, compared to last week’s 6.25. 5-year adjustable mortgages averaged 6.35%, up from 6.33%, and interest on 1-year ARMs was at 5.67%, a little higher than a week ago, when it averaged 5.65%

Fannie asks regulators to raise financing cap

Fannie Mae has reportedly asked the Office of Federal Housing Enterprise Oversight (OFHEO) to increase the maximum amount of loans it can hold in its portfolio. Fannie says this will help stabilize the market and provide financing for potential home buyers. The mortgage giant is required to keep mortgage holding at or below $727 billion. Freddie Mac, Fannie’s smaller sibling, is also subject to a similar limitation. Shares of Fannie Mae gained more than 10% on the news and closed at $62.50 on Monday.

Regulators generally try to prevent the two GSEs from controlling too large a part of the market, because of the potential consequences for the broader economy. Allowing Fannie to keep more loans in its portfolio, or raising the cap on ‘conforming’ loans would probably be good for the market, but I don’t think regulators find the thought of permitting Fannie and Freddie to grow even larger very appealing. It’s a well-known fact that in some areas nearly all loans are ‘jumbo’ because the median is well above the $417,000 limit for a ‘conforming’ loan financed by Fannie Mae, so there must be something inherently wrong with the classification in general. While setting ‘local’ limits for ‘conforming’ loans sounds impractical, there must be something that can be done to make the system more realistic.

Another thing that could help spur the market would be a rate cut, but choosing the right policy in the current circumstances is a very complex problem which the Fed will have to resolve on its meeting this week. Most analysts believe that the Fed fund rate will remain at 5.25% where it’s been for more than a year, but a cut is likely sometime by the end of 2007. Much will depend on how the economy behaves, including such indicators as inflation, employment, the dollar, and the whole range of housing-related problems. Housing prices are another concern that needs to be addressed. They grew beyond any reasonable limits during the housing boom, so in the long term, a drop in prices would be considered a good thing. Providing more financing, or cheaper financing, would only slow that process down.

Freddie Mac: home sales will keep falling

Freddie Mac, the second-largest mortgage buyer, paints a bleak picture of the current situation in the housing sector, and makes a rather gloomy forecast for the months ahead.

Just when economists hoped for a rebound in home-buying activity, mortgage rates jumped from 6.15-6.25% to 6.50% and higher, cutting into affordability. According to the mortgage giant, home sales in 2007 will probably drop to their lowest level since 2001, totaling 6.28 million, 7.1% lower than last year. In 2001, home sales totaled 6.20 million. The interest rate on a 30-year fixed mortgage will probably be 6.7% this quarter, up from 6.2% in Q1. Inventory reached a record of 4.43 million in May, while sales dropped to a 5.99 million annualized rate, the lowest figure in four years. According to analysts, the bottom in home sales will probably be reached in 2007, but price declines will continue into 2008.

Freddie Mac is also revising downwards its forecast for gains in the home price index. Last month’s forecast of 1.5% is being revised to an increase of 1% for this year. Housing starts are expected to decline 18% in 2007, to a total of 1.48 million. The percentage of mortgages entering foreclosure is at an all-time high of 0.58%, subprime foreclosures are at 2.43%, the highest level in 5 years, and foreclosures on prime loans reached a record 0.25%. So, don’t expect good news from this part of the economy till the end of the year.

Low bids for Bear Stearns Hedge Funds

Investors in the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leveraged Fund, one of the two troubled hedge funds that have been making the news lately, are trying to sell their holdings at fire-sale prices. Unfortunately, the best bid so far is 5 cents on the dollar, much less than the 11 cents investors hoped to get.

The other, “less geared” fund, called High-Grade Structured Credit Strategies Fund is attracting bidders at 30 cents, compared to the asking price of 70 cents on the dollar. Both these funds are backed by subprime mortgages and highly leveraged, meaning that their market price was probably much lower than their estimated value. The low bids are indicative of the risk associated with the subprime business and all securities backed by mortgages. Looks like troubles in subprime are spilling over to other sectors after all.

And now, something economists feared is already happening. Another hedge fund seems to be heading the same way as the two Bear Stearns funds. United Capital Asset Management is suspending redemptions from its Horizon funds, without liquidating them – for the time being. The funds’ manager, John Devaney, predicted the current turmoil in the sector, but couldn’t avoid running into trouble.

The week ahead: a Fed meeting, and so much more

The Fed will be discussing financial matters on Wednesday and Thursday, and, although a change in interest rates is unlikely, economists will be paying much attention to the Federal Reserve’s statement, to be issued at the end of the meeting. With inflation at an annual rate of 2.2, chances for a rate cut seem to be non-existent, as the Fed aims to contain inflation in the 1 to 2% range. The official statement, however, will have a considerable impact on the market’s performance.

Other statistics to be reported this week include existing home sales, new home sales, a survey of consumer sentiment, and a revision of the Gross Domestic Product. All this should provide a clearer picture of the current economic situation, and some insight into the housing market’s near future. Most publications indicate serious pessimism in regard to Real Estate and predict that more bad news is on the way.

Home builders Lennar Corp. and KB Home will be reporting quarterly results this week. Home builders are generally suffering losses in the current market, as both sales and prices decline and homes stay on the market for months, so their reports will provide valuable information on housing as well.

Rise in mortgage applications

U.S home mortgage applications rose 1 and a half percent last week, fueled by an increase in mortgage refinancing. Is this a good sign about the health of the U.S housing sector? I doubt it. First time mortgage applications are still way down despite the recent uptick in refinance loan applications. A look at the four week moving average shows it was still down 1.6 percent for the month.