Tag: Filtering News From The Media

Interest Rate Spreads And Why The 10 Year Treasury Is Not The Best Indicator Of Mortgage Rates

One of the topics that comes up on a daily basis with my clients is the relationship between mortgage rates and the headline-grabbing interest rate reference points like the 10 Year TreasuryNote, or the Federal Funds Rate.

A very common misconception is that mortgage rates are based on the 10 Year Treasury Note. I am not exactly sure what the logic there is, but I have heard people say that the average 30 year mortgage lasts only10 years. Seems like a pretty loosey-goosey way for a bank to call out a price for lending their money out on a 30 year term. Do mortgage rates correlate to the 10 Year Treasury at all? Over time, mortgage rates and the 10 Year Treasury do trend in the same direction, but on a day by day basis, they often go in different directions, or at least at a different pace. There are separate specific implications for each, and they react to a different set of data points in different ways – at times, the differences can be significant.

The other question I get rather frequently is how the Federal Reserve will impact rates with their recent string of cuts to the Fed Funds rate. People continuously expect that its best to wait until after the cut to take advantage of lower rates. Again, not the correlation you are looking for. The Fed has cut 7 times in the recent cycle, and on the first 6, mortgage rates spiked in response. On the last one, rates went down a little. Do mortgage rates react to the Federal Reserve actions? Absolutely, but its the greater economic context that matters at the time, and dictates the type of reaction.

So what’s the best metric for determining mortgage rates? MBS, or mortgage-backed securities, aka mortgage bonds. Read a definition of these here. When mortgage bonds trade at higher prices, the associated interest rates drop. This tells lenders for new mortgage issues what the current value and rate of return is on long-term bond money, and helps them set their rates.

Each of the first 6 cuts this time around have brought on a perceived increase to the threat of inflation. Long term fixed-income securities, like bonds, Treasury Notes, etc, HATE inflation. If you were a bank, and committed to lend 100 dollars to somebody for 30 years, and then inflation doubled, your 100 dollars would be worth far less than you had expected it would be when you loaned it out. So you would loan your next 100 dollars at a higher interest rate to compensate. Accordingly, rates on mortgages jumped at each time.

Then on the most recent cut, the Federal Reserve hinted at the idea that this would end the cycle. It gave the bond market confidence that no further inflation pressure would be invited, and the bonds rallied on the news. Rates went lower.

The bottom line when it comes to trying to predict mortgage rates, is that you need to know where MBS are trading, and what the climate is for them amidst the constant inflow of economic data points. They react very strongly to things like the Unemployment data, GDP, CPI, PCE, PPI, Home Starts and Sales, and a bunch of other metrics. Depending on the mood, different indicators have different impacts. If inflation is a hot button, the inflation barometers like the CPI and PCE will have heavy influence. If we are looking for indicators of recession, MBS will be sensitive to GDP, Consumer Confidence, Retail Sales, etc.

The Cleveland Federal Reserve has an article out discussing the increasing spread between Treasury and mortgage rates. With the current credit crisis, money has rushed into bonds as usual. But mortgage bonds have been relatively less appealing, as the whole mortgage marketplace is at the epicenter of the crisis. Last time we had a recession, money flooded into all bonds, Treasury and especially MBS because the housing economy was strong, and MBS values were thus very secure. This is why we are seeing a lack of correlated movement between these two instruments.

If you are entrusting a mortgage professional with the management of your debt, you need to align with one who understands interest rates. They need to specifically understand the market for mortgage-backed securities, and the economics behind the current credit and liquidity crisis. If the person you are speaking with tells you that mortgage rates are based on the 10 Year Treasury, or especially if they call the 10 Year Treasury Note a Treasury Bond, there’s a risk they are going to mishandle your business. And if they say they ‘can’t see into the crystal ball’, its likely a sign that they don’t have a clue what upcoming events might be influencing rates.

What Was Wrong WIth The Mortgage Business? Stuff Like This

Here is a story about an internal memo from a major bank that was leaked out to the public, and to the media. It was a primer on how to trick the internal underwriting software into liberally approving loans that may not pass muster with a human underwriter. Such programs will provide a fast track to closing that essentially bypasses the human “manual” underwriting effort. The secret? Inflate the applicant’s income to make it look so “over-qualified” that the underwriter doesn’t even ask to see proof of income.

I know, I know. Just read the article. This represents an investment appetite well out of touch with risk assessment, and is symptomatic of an exuberant market. I’m not a huge fan of the ‘media tint’, especially with their ability to adequately report on the credit crisis, and this is no exception. There are misrepresentations, and the media loves to portray the entire industry as deliberately trying to hurt consumers. Keep in mind, banks don’t benefit when they write loans that go into default. Even though they often transfer the liability through securitization into the secondary market, they still have rating agencies , shareholders, and reputations to answer to. Granted, there were flaws all up and down the system, but that’s my point. The banks were not looking to make stupid investments so they could deliberately cause people to buy – and then lose their homes. They got carried away much like the borrower who signed their name to the application with bogus data got carried away. All based on the expectation that the home would keep rising in value. Economics.

John Mauldin Waxing Political

Frequent visitors know I am a fan of Economist John Mauldin (recently voted as the runner up to Warren Buffet for MotleyFool‘s Investor of the Year Award). I find his economic insights both informative an entertaining, and his newsletter can become addictive to be perfectly honest. Give it a try here.

I don’t usually get into politics, mainly because I find it difficult to find politicians worthy saying nice things about. And you know what they say about what to do when you can’t think of something nice to say.

But if Mauldin can make an exception to the rule, I can at least point toward his newsletter. I think it is important to read. I can point to several cases where politics over-ruled economics and caused major problems in our economy (take The Great Depression for one). There is a real danger when politicians pander with empty promises that they know they cannot (or should not) back up. Telling the voting public what they want to hear – or what the candidate thinks they need to hear – when it isn’t realistic or good for us anyway is a reckless but common practice by these folks. I’ll leave it to Mauldin to pick up from here to illustrate why when it comes to our economy, almost all politicians are donkeys.

Read it here. Enjoy…

How’s This For "Contained Meltdown"?

I heard one economist recently refer to the current credit markets situation as “well-contained. Sure, contained on Planet Earth…”

A large part of the reason the markets are so erratic lately is because there is so much uncertaintly as to how much damage has been done and not yet acknowledged. How much more money will be lost, and by who? Financial engineering has helped build layers upon layers of cloaking around the bad investment eggs, and the unwind is coming in baby steps (which is good, time helps the markets digest what is clearly a big rotten meal…)

So here’s a story from a colleague of mine, which highlights the defensive posturing by creditors who are clearly fearing this “unknown risk” in the market. It also signifies a huge leap in terms of the webbing between “subprime” mortgage issues and areas of other financial concern. This is one way how the virus is NOT being contained…

“How far will this reach into credit cards? One fellow I know received a letter from American Express, dramatically lowering his available credit limit. Our analysis of the credit risk associated with customers who have residential loans from the creditor(s) indicated in your credit report.” He has two loans: one from ING Mortgage and a HELOC from JPMorgan Chase. He called Amex and they said: “We were told by Experian that your mortgages are with ‘risky lenders”. They also said that “information received from a consumer credit reporting agency was factored into the decision.” (He has no delinquencies. They listed standard reasons, inquiries, balances, etc.) He wrote, I have never seen credit being denied or reduced for something 100% out of the borrower’s control.”

Something to keep a watch on as the market feels for a bottom, those in position to lend money for any reason are proceeding with extreme caution…

Stock Market Cheatsheet

I found this on Barry Ritholtz’s Big Picture blog. It seems to sum up the recent stock market sentiment pretty well:

This is circulating via email around trading desks:

>

Cheat sheet: reacting to data and market releases

weak data = Fed ease, stocks rally

consensus data = lower volatility, stocks rally

strong data = economy strengthening, stocks rally

bank loses $4bln = bad news out of the way, stocks rally

oil spikes = great for energy companies, stocks rally

oil drops = great for the consumer, stocks rally

dollar plunges = great for multinationals, stocks rally

dollar spikes = lowers inflation, stocks rally

inflation spikes = will inflate all assets, stocks rally

inflation drops = improves earnings quality, stocks rally

Making Sense Of Today’s Market

When speaking with clients lately, it has been made clear to me that the current state of the mortgage marketplace has affected everyone on very different levels. Some people are clearly touched by the panic and have several questions about “what does this mean to me?”, while others seem oblivious that this ‘credit crunch’ thing has anything to do with them now or in the future. More power to them. A panic state – when widespread – is a breeding ground for irrational individual behavior.

The financial talking heads in the media have a few challenges in getting rational information through to the public. For one, many of the faces on the news channels don’t always follow it themselves. But when they surround themselves with economists and analysts who do get it, they need to make sure they speak in parlance that the general public can handle. CDOs, RMBS, ISM, and BBB- are not terms that reside within the daily vocabulary of people with professions outside of the financial arena.

To that concern, here are two articles that offer a broken-down explanation of what is going on right now in the mortgage market, why ‘the subprime meltdown’ affects other areas of borrowing money, the role of the Federal Reserve, etc. You can access them here and here.

How A Recession In Housing Affects The Rest Of The Economy


Watch CNBC for 5 minutes and 30 seconds and you can get a good sense of the attention being paid to the day-to-day developments in the housing and mortgage markets. At this point it is no secret (or real surprise) that the housing industry is in a recession. We have increasing inventory, slowing sales, and decreasing prices. The construction unemployment rates are rising. The mortgage industry is facing a fairly turbulent adjustment with several companies collapsing on short-notice, and leaving several consumers left waiting for the money to buy their homes.

But most agree that these adjustments are good for the industry’s long-term benefit. This is typical of the market cycle. Its just that the other side of the cycle carried the industry so far for so long, that this side feels more intense.

Paul Kasriel of Northern Trust highlights some of the ways in which the housing industry’s growing pains can spill over into the greater economy:

“The tentacles of the housing recession are reaching beyond consumer spending. Freight haulers, both truck and rail, are reporting weaker volume growth because of the decline in residential construction activity. With fewer housing developments popping up in suburbia, newspaper advertising revenues are being adversely affected. And the producers of construction equipment, such as Caterpillar, are experiencing softer domestic sales.”

It will be interesting to watch this develop. And of particular interest will be to monitor the role of the Federal Reserve, who is attempting to tread a fine line between averting a significant economic recession and giving the market participants false confidence through bail-out gestures.

CDC National Health Interview Survey Has Some Interesting Data

For example, it found that adults in wireless-only households were more likely than adults in households with landlines to report binge-drinking, smoking, uncovered health insurance, and limited access to health care.

Shocking! How many “adults” do you know who don’t have a landline phone? Its a youtube generation thing folks, or at least a more youthful one. My guess is that if we controlled this study for age distribution, we would conclude that:

“younger people are more likely to use cell phones in favor of having a landline phone”

As opposed to:

“people in households with no landline tend to be binge-drinkers”

No knock against the youthful cell phone sector here – my mother is brilliant, but teaching her to use a computer was maddening because she learned how to type on a typewriter. Word Processing felt weird and strange. Just took her longer to adopt the idea, but now she’s working on a PHD and setting the curve academically. Try doing that today without a computer.

To all you cell-phone only kids out there, there once was a time when we had to plug the phone into the wall, and dial with our fingers. I know, crazy, right?

Who wants a drink?

John C. Glynn, CMPS
Real Estate Finance & Mortgage Planning
San Francisco

Beware the Media!

Long-time friends and colleagues know me well enough to know that I take in my news with a fair amount of skepticism. No matter who you are listening to (in and out of media) its wise to keep mindful of their bias and objectives. Its a pretty simple rule. This is why the nightly news advertises stories about which of your dinner ingredients might kill you tonight!… but the story runs at 11pm… they just want some attention so they can sell commercial time to their advertisers.

Look at the difference between two different stories on the topic of baby-boomers and the implications for housing. From the perspective of Real Estate and Mortgage companies, Realty Times reports of the generation “They’ve got all the money … They’ve got all the real estate, too”. The article makes the case for the next wave of Real Estate activity with baby-boomers leading the charge by buying 2nd homes and vacation property. This is no new speculation by the way; stories about this appear weekly.

But look at this article. It basically reports that baby-boomers are far more likely to remodel their homes than move to the beach, or the desert, or to buy a 2nd home on the shore of some lake. And who is behind the so-called study? Home Depot!

The only way you can get a sense of anything out there, especially in the real estate market, is to get as many angles and opinions as possible. Do your best to triangulate reality among all of the self-serving junk in the news.

In Defense of The Option ARM


Business Week recently published a scathing article about Adjustable-Rate Pay-Option Mortgages (aka The Option ARM) that has sent a pretty good ripple through the lending community. Well, big surprise, this one-sided eye-grabbing piece is typical of the flesh-eating virus style of media-induced panic.

Before I defend this loan product outright, I want to be clear on something: there is no doubt in my mind that this is an often-abused and often-misunderstood product. But I do feel the need to point out a few problems with the article, and and present another side to these loans. Read the article here.

The key benefit for Option ARMs is the payment flexibility, where a borrower is allowed to make minimal monthly payments on their home loan. It is a strictly cash-flow driven financial tool, and generally is not the cheapest type of loan available. As is with any other time value of money concept, you are paying a premium for this flexibility. This may be in the form of higher interest cost, higher risk of increasing interest, or in the current rate environment, both.

Business Week makes a fair claim that many mortgage brokers are pushing this product for inappropriate borrower scenarios, and this is a real problem that I agree with. The simplified sequence looks a little like this:

Home owners are attracted by the low minimum payments – commonly featured in mortgage broker’s radio and print advertisements – and do not ultimately understand how the loan works before they sign up. They make minimum payments for a while, and then get caught by surprise when they realize that (A) their loan is growing in size and (B) their payments minimums are adjusting to keep pace with this increasing balance. Add to the mix a realization of a slowing appreciation rate for US real estate, and the stage is set a full-blown panic. All the media needs to do to sell a few magazines is run headlines like “Nightmare Mortgages”.

Throughout this article, BW gives examples of some people who are feeling the pinch of rising rates and payments on their Option-ARM. She presents that they have been screwed by their mortgage broker, and that the mortgage broker has been led along like a puppy by banks to sell these products by offering high margin revenues for the product. Its the man stickin’ it to the people yet again, and the result is a shaky American financial infastructure, ready to buckle beneath its own weight when Mr. & Mrs. Average Homeowner come up short on their upwardly adjusting mortgage payments.

Let’s not forget how the media makes a living. Do I have to make the case that they have a history of blowing things out of proportion? Is it obvious already that they sell more magazines, more commercial time, more web impressions when they have really dramatic news to talk about? A recent James Bond movie made fun of a corrupt media mogul who was creating global conflict to sell newspapers. Its a parody, but it comes from the every day media machine.

And they are blowing things out of proportion here…

First, no responsibility is put on the borrower, the consumer, the buyer to educate themselves. The American consumer is presented as a feather in the wind, succeptable to any mortgage broker’s lousy self-serving advice. I don’t buy it. The consumer controls the mortgage process more today than ever, educated (albeit in a commonly misleading way) to a dangerous degree. They think they know it all, but they dont know enough. They surf the web for info, and think they can walk into the transaction telling the mortgage broker what is best for them in the mortgage universe, and how much it should cost. What choice does a mortgage broker have but to tell them what they want to hear, that the lowest payment out there is based on a 1% Option ARM start rate?

Well, that is your common mortgage broker for you. So who can blame the consumer for making every attempt to arm themselves with the latest info, and come in to the transaction with their defenses in place? The consumer fears the mortgage broker, and the mortgage broker fears the consumer. This is a recipe for a bad deal. From my perspective, this is the ‘Nightmare Mortgage’. All this drama about Option ARMs is just a symptom of that problem.

In most of the case studies, there is no mention of the situation prior to the Option ARM. Most of these people are in over their heads already. Harold can’t afford any mortgage product on the income quoted. The Shaw’s dont have enough income to qualify for their mortgage, etc. Did the Option ARM really get them in trouble, or are were they already headed there? Maybe they mismanaged their finances, or just had some tough turns in life. It happens.

But lets not let these folks get away with blaming everything on the bank or the broker. While I do agree with some abuse from inside the business, is the consumer not required to take responsibility of their own situation? Not reading the terms? Not taking the care to find a reputable broker? I mean, I can go into WalMart and buy a shotgun, but if I shoot somebody with it, I am not allowed to blame it to the blue-vested clerk who rang the register…

These loans are promoted with 1%-2% pay rates as the hook. Does it not seem too good to be true? It is! Theres more to this story – a lot more! I hear radio ads for these, and I get the flyers in the mail. Most of the advertisements seem criminal to me. And I do think that a large segment of this industry is participating in a misleading game, and delivering a back-handed slap to people in a time-sensitive, major financial transaction – often leaving them with little choice or time to react once they realize the bigger picture.

To date I have talked more people out of the Option-ARM than I have put into the Option-ARM. But we still put them together for the right situations.

In todays marketplace for real estate finance, there are countless options. There are so many products that can be tweaked to fit a loan scenario, where you can emphasize one goal over another – financial, personal, etc (related to taxes, investments, inherritance, divorce, retirement, education, timing… the list can go on and on…). The Option ARM represents one of the most sophisticated tools available, but you need to know when and why it is right for you. A Certified Mortgage Planner isn’t likely to lead you astray; make sure you are working with somebody who can educate you, and plan with you to weave the mortgage product with your greater financial goals.

Work with an expert. Get a referral from somebody you trust. And then let them work with you to provide a mortgage plan. Only you know your financial habits and objectives. And I guarantee you that a good mortgage planner knows a lot more about their business landscape than you do. If you can’t put trust in them to help you navigate real estate finance decisions, then its not the right person to work with.