The Mortgage Reports Blog

More Evidence That You Can't Use The 10-Year Treasury Note As A Gauge For Mortgage Rates

For years, people unfamiliar with the mortgage industry have said that the government's 10-year treasury note is a reasonable proxy for mortgage rates.

This is flat out wrong.  The only security that matters to mortgage rates is the price of a mortgage-backed bond.

The chart at right supports this idea.  It's shows the interest rate "spread" between the 10-year treasury note and the 10-year Fannie Mae note.

Notice how the spread is widening.

On a technical basis for Wall Street, the widening spread means that debt issued by the conforming mortgage securitizer is considered more risky of an investment.

On a personal basis for Main Street, though, the widening spread reflects the modern problems of Fannie Mae which will likely lead to both higher mortgage rates and larger loan fees for Americans.

Watching the 10-year treasury is not an effective way to track mortgage rates.  And if it was an effective way in the past, the chart shows us that it's certaintly not any longer.

(Image courtesy: Wall Street Journal)

The Disassociation Between Mortgage Rates And The 10-Year Treasury Note

This chart may read like gibberish, so I notated it. 

It's meant to illustrate that daily mortgage rates are not based on the yield of the 10-Year Treasury Note.  Sure, there is a long-term correlation between the two, but "long-term" doesn't do us any good when we're looking to lock an interest rate today.

We've covered this topic in-depth once before, but it's worth revisiting. 

Mortgage rates are based on the price of mortgage-backed securities, plus all applicable fees.  Specifically, the formula works as follows:

Getting Mortgage Rates Clues From The Stock Market

The trend is still holding, so to hammer the point home: to know what mortgage rates are doing lately, just check the stock market.

• As stocks go down, mortgage rates go down
• As stocks go up, mortgage rates go up

This is not a long-term, direct relationship by any means but it's holding true this week. 

The interplay between stocks and mortgage rates is a welcome development for home buyers because it's simpler for laypersons to follow the stock market than it is to follow the mortgage-backed securities market.  When you know what to expect with rates, after all, the mortgage shopping "experience" can be a little bit less stressful.

So, enjoy it while you can -- by next week, we could back to watching esoteric data like Balance of Trade figures.

(Image courtesy: Google Finance)

How To Track Mortgage Rates Using The Stock Market (This Week)

Home buyers and other people in the market for a new mortgage should be thanking the Fed right now.

In its post-meeting press release last week, the Federal Open Market Commitee made a few choice statements about the economy that helped mortgage rates fall for the first time in 6 weeks.

The first Fed remark was that inflation appears to slowing and that it should be under control within 6-9 months. Comments like this are good for mortgage rates because inflation causes mortgage rates to rise.

The absence of inflation, it's worth noting, tends to help mortgage rates fall.

Then, the Fed also said that economic growth should stay steady this year because the full impact of its prior rate cuts have yet to work its way through the economy. 

This, too, is good for mortgage rates because economic growth is good for the U.S. dollar and a strong dollar tends to be good for mortgage rates.

Why Even "The Gamblers" Are Asking To Lock Mortgage Rates As Early As Possible

If you look at mortgage rates today and compare them to January's numbers, not much has changed:

• 30-year fixed: Still hovering near 6 percent
• 7-year ARM: Still lower than 30-year fixed rates
• 5-year ARM: Still lower than 7-year ARM rates

But on a day-to-day basis, the market is not as smooth as the comparison would have you believe.  Mortgage rates are more like The Vortex -- two double-loops, a corkscrew and a batwing. 

Enough to make you vomit.

If you've been shopping for a mortgage lately, you know what I mean (alternate link) and unless you're getting my Twitter updates piped to your mobile, you're left looking for clues anywhere you can find them.

For example, although mortgage rates were the mirror-opposite of the stock market Thursday and Friday, there's no long-term relationship between the two upon which we can draw.  We can't say "when stocks are up, rates are down", or vice versa, because there are many days that the two move in tandem.

The biggest clue we have about mortgage rates is that they respond to expectations about the economy.  Because of that, we should expect the loop-de-loops to continue until 1 of 3 things become clear:

What Will Happen To Mortgage Rates When The U.S. Dollar Strengthens

Broadly, mortgage rates fell in 2007.  It's befuddling because there are two major reasons why mortgage rates should have increased in 2007:

1. The U.S. dollar took a precipitous decline against world currencies, devaluing mortgage bonds
2. Inflation ran beyond the top of the Fed's comfort zone for most of the year, devaluing mortgage bonds

When mortgage bonds get devalued, there should be less demand for them.  But that wasn't the case.  If mortgage rates are lower now than they were a year ago, it means that demand for mortgage bonds must be higher.

See For Yourself Just How Much Impact Foreign Nations Have On U.S. Mortgage Rates

I rely on charts to tell stories from time to time; that much you know about me by now.  And, I'd be lying if I said using two charts to tell a story doesn't get me uber-excited.

Sometimes, two things are just made for each other:

• Peanut butter and jelly (proof)
• Jam and Joey's girl from the Xerox place (proof)
• Foreign Net Treasury Coupon Purchases and the Path of The 30-Year Fixed Mortgage Rate (see above chart)

It's almost poetic.

We know that mortgage rates are based on the price of mortgage bonds.  And we know that foreign nations buy a lot of U.S. securities (including mortgage bonds).  Well, by mashing up two charts, we can actually see how bond and buy-side economics work.

The red bars represent foreign demand for U.S. government-issued bonds.  The fuzzy blue line represents the average 30-year fixed mortgage rate. 

Author's note: I am assuming that foreign demand of all US securities follows the same basic trendline as the subset that is foreign demand for US treasuries.

According to the chart, when the red bars get bigger, demand is increasing for U.S. treasuries and rates are expected to fall.  The overlay verifies that.  It also verifies the opposite -- as the red bars get smaller, mortgage rates tend to increase.

Now, foreigners are not the only purchasers of mortgage bonds, of course, but I found this homemade mashup to be exceptional because it shows a clear association between the two.

Source
Bond Market Update
Briefing.com
October 16, 2007

Graph the trend
Bankrate.com
October 16, 2007

Measuring The Statistical Insignificance Of The Monthly Jobs Report (September 2007 Edition)

This morning, the Non-Farm Payrolls report showed a net loss of 4,000 jobs in the month of August, its first net decline since 2003.

Markets expected some weakness in the report, but not this kind of weakness.  Already, mortgage markets are up 31 basis points today. 

That's a swift, powerful reaction, especially considering that the unemployment rate remained unchanged at 4.6% and is viewed as "strong".

Today, mortgage rates are moving because the investors think the Fed now has an economic reason to lower the Fed Funds Rate later this month. 

But is the economics even there?  If we look deeper at the numbers, we can answer the question(s): What is the true significance of this morning's Non-Farm Payrolls report?  Is the mortgage market's reaction justified? 

Consider the following (subject to revision in October and November):

• 4,000 jobs were lost in August versus expectations of 110,000
• 24,000 fewer jobs were created in July than previously measured
• 57,000 fewer jobs were created in June than previously measured

Adding it up, today's actual news was that the number of working Americans was off by a measure of 195,000 against the total number of employed people of 146,000,000.  In percentage terms, the "surprise" represents 0.134% of the overall workforce.

Now, let's put that 0.134% adjustment in mathematical perspective:

• 0.134 percent is one foot in the height of the Golden Gate Bridge
• 0.134 percent is one person living in Foxfield, Colorado
• 0.134 percent is one double in the storied career of Charlie Hustle

Statistically, 0.134 percent is insignificant. 

And yet, mortgage rates are plowing lower today while economists chirp about dramatic economic weakness tied to the credit markets.  If I hear one more person say that Fed has to lower the Fed Funds Rate because of today's payroll report, I'll barf.

So, just like the last time I did a study like this, the market is reacting strongly to data because of its psychological implications, not because of a fundamental analysis.

More Signs That Liquidity Is Returning To The Mortgage Markets

The worst may be over for home buyers, debt consolidators and other folks in need of mortgages.  That is, unless you're a Michigan fan -- in that case the worst may be ahead.

Author's note: I graduated from Penn State and currently live in Buckeye country. Showing this video is different from publically rooting for the Cubs or the White Sox and alienating half my audience, right?  Isn't it...?  Anyway...

A few interesting notes from last week and today make me think that some form of order is being restored to mortgage markets.

Good News For Mortgages #1: Pricing incentives on jumbo loans

A very large bank is offering pricing incentives for all jumbo, fixed, full documentation loans.  If you meet the criteria below, your rates won't be as bad you may have been told.

• Mortgage greater than $600,000 mortgage
• 30-year fixed mortgage
• Willing to prove income and asset with documentation

So far, I only know one bank that is making this discount available.  You may need to work with a broker to make sure you get it, or hope that you do your banking there.

Good News For  Mortgages #2: Large Alt-A lender places jumbo mortgages in secondary market

IndyMac sold $590 million in mortgage bonds to the markets for the first time since July 19.  About 40% of those bonds were rated "AAA", meaning the risk is deemed to as close to nil as possible.  Only government bonds are rated safer.

IndyMac's placed offerings were for jumbo mortgages.

Good News For Mortgages #3: Foreign National lending pricing continues to improve

Foreign National lending is a niche and one in which I like to work.  It's very encouraging to see that mortgage rates are still improving for this portfolio product.  Lending to a non-U.S. citizen can be a risky proposition for a bank because a foreign borrower has a different incentive system to pay a mortgage. 

If a U.S. citizen walks away on a mortgage from a U.S. bank, getting a loan from another bank in the future is a huge challenge.  For a foreign national, it just means limiting their real estate exposure to the other 193 countries in the world.

Because the risk premium is reducing for foreign nationals from Ireland, England, Spain or wherever, it suggests brighter skies for all mortgage borrowers.

UPDATE: 1:30 ET -- Additional placements reported in secondary mortgage market

From the Wall Street Journal Online, Thornburg Mortgage securitized approximately $1.4 billion in adjustable-rate mortgage loans over the past few days.  Liquidity, it appears, is returning.

Foreign Nationals: Today's Sign That Liquidity May Be Returning To The Market

I am working with a Dublin-based real estate developer, providing Irish real estate investors with mortgages for United States-based properties. 

A project on which we are currently working has been interesting in context of how the mortgage market is changing.

When we started work on this Chicago-based condo building, the lending landscape was very different than it is today. 

Our initial lender evaluation for the buyers/investors included eight separate banks and a multitude of mortgage products. 

As of today, we are down to one. 

It reminds me how thankful I should be that I represent buyers instead of a Hedge Fund, or other investment company.

Because I am a broker and not a bank representative, the mortgage market can crumble around us but I can still service Foreign National buyers without even a blip of  disruption -- when one bank closes it doors, I still have a stable of banks from which to choose.

And that's precisely what's happening. 

Most of the lenders in our initial evaluation have disqualified themselves for a number of reasons:

• Some <ahem> "closed their doors"
• More than a few tightened their mortgage guidelines and now the approval process is an onerous one
• Most raised interest rates so high that the math of investing in real estate in America no longer works

There is still (at least) one bank that fits the bill and I was pleasantly surprised this morning when I saw that its interest rates had dropped by 0.250% for the borrower profile and product that the Irish buyers will be using.

That's an overnight movement and signals to me that risk premiums may be dramatically reducing for certain sectors of the mortgage lending market.  If Foreign National lending risk is reducing, other areas may not be far behind and that could help provide some support to the Alt-A and portfolio lending markets -- all good things for housing as a whole.

I know it's a fairly narrow market but there's a core group of international readers around here for whom the Foreign National lending niche is important.  If it's important to you, it's important to me.  I'll be sure to keep an eye on things for you all.

(Image courtesy: University of Texas)

Interview with First Business: Will the Fed Cut Rates?

I interviewed with First Business anchor Anchor Beejal Patel this week.  First Business produces news "shorts" that are syndicated nationwide. 

The story: "How would a Fed rate cut impact mortgage rates?"  You all know my answer -- it's well-documented around these parts.

I am a little embarrassed about having to use somebody else's office for the spot, though; you'll notice the photo of his three kids and one of their rainbow drawings over my left shoulder.

The rainbow does complement my tie nicely, though...

The Majority of Americans Can Still Get Loans (And Eat Their Bread)

Most American homeowners:

• Live in homes whose loan sizes are less than $417,000
• Own one home and call it a primary residence
• Can document their income using W-2 statements and/or tax returns
• Have at least a modest savings account
• Have at least the average credit score of 678
• Do not have a history of bankruptcy or foreclosure
• Have monthly income that at least triples their monthly debts

These are the general and basic criteria of a Fannie Mae and Freddie Mac loan. 

Fannie and Freddie are government-sponsored entities whose charter is to help keep mortgage money flowing to people that want it.  The rough rules by which they'll lend are outlined above and encompasses the majority of America.

On the other hand, the host of privately-funded lenders that have bankrupted, merged or otherwise shut down had rules that apply to a small subset of Americans with very specific needs. 

Think grocery store shopping:  The GSEs are the regular bread, the mortgage banks are the gluten-free.

The majority of Americans qualify for Fannie- and Freddie-backed home loans so you shouldn't get nervous when reading the headline news.  For most of our country, the lending options are plentiful -- everyone can eat from world's largest loaves of bread.

(Image courtesy: World's Largest Roadside Attractions)

To Know Where Mortgage Rates Are Moving, Watch The Proper Indicators

If you're a first-time reader, here's the first thing you get to learn at The Mortgage Reports:

Mortgage interest rates are determined by the price of mortgage bonds.  Nothing else, nothing more. 

If mortgage bond prices are down, mortgage rates will be higher.  If mortgage bond prices are up, mortgage rates will be lower.

That's it.  Pretty basic stuff.  Except that mortgage bond pricing information is not very accessible to the general public. 

This includes the press.

Because the mortgage-backed bond market is somewhat foreign to the media, a lot of them use a government bond called the "10-Year Treasury Note" when predicting where mortgage rates will go.  The 10-Year Treasury Note is very easy to follow because it's accessible -- just turn on CNBC or Bloomberg and you'll see it in the ticker.

And, usually, it's okay to use the 10-Year Treasury Note as a predictor of mortgage rates because the two tend to move in the same direction.  But there's no direct correlation between them.

It would be like saying that Microsoft will trade higher because Google beat its earning estimates.  Sometimes, Google will pull up the whole Technology sector, but there are plenty of days when it doesn't.

It's like dreaming about Gorgonzola cheese when it's clearly Brie time.

Unfortunately for mortgage rate shoppers, a lot of loan officers don't get the difference.  They, too, will use the 10-Year Treasury Note as a mortgage rate benchmark.  Again, most days it works, some days it doesn't.

Yesterday was one of those days.

At one point, mortgage rates were getting killed (down 19 basis points) while the 10-year treasuries were thriving (up 53 basis points).  Into the afternoon -- even as the 10-year treasury note extended its gain to 100 basis points -- mortgage bonds had barely recovered to flat.

If your eyes were on the wrong indicator, you would have expected mortgage rates to fall yesterday.  They didn't.  And this same divergence has occurred several times in August.

For people watching the wrong indicator, it may have led to costly rate lock errors.

The only security to watch with respect to mortgage rates each day is the price of mortgage-backed securities.  And if you didn't get the message this time, stick around and I'm sure I'll bring it up again sometime soon.

How Sub-Prime and Alt-A Mortgage Markets Are Behaving Like NFL Draft Picks

Did you see the BNP Paribas press release last week that said it's halting withdrawals from some of its funds?

My favorite part is how blunt the first sentence is below (bold added for emphasis):

"The complete evaporation of liquidity in certain market segments of the US securitisation market has made it impossible to value certain assets fairly regardless of their quality or credit rating."

In other words, BNP stopped allowing withdrawals because it has aucune idée just what it's holdings are worth.  Imagine if you went to the ATM to take out $100 in cash and the bank couldn't give it to you because it doesn't know what the $100 is worth.

Same thing.

It's now been about 10 days since the "impossible to value mortgages" stage began for banks worldwide. If you're having trouble understanding why, this analogy should help.

Think of the NFL Draft.

The NFL Draft was held April 28-29, 2007 but it took two weeks for the first player to sign and he was a third-rounder.

In the NFL, no player wants to be the first to sign at his position because -- as soon as he does -- he is setting the value for every other player at that position.  If a linebacker drafted in the 3rd round signs with his team, he is setting the relative value of all of the other linebackers drafted that day.

If the LB was drafted in the 4th round or higher, his value is less.  If the LB was drafted in the 3rd round or lower, his value is more.  Until a player at linebacker signs, though, team owners and player agent don't know what a "2007-drafted linebacker" is worth.

This is one of the reasons why the #1 pick of the draft -- QB JaMarcus Russell -- is still holding out for a contract from the Raiders.  The next QB in the draft order was Notre Dame alum Brady Quinn at #22 and Quinn finally signed his contract with the Browns last week.

Quinn, presumably, was just waiting for the next quarterback after him to sign because just 13 days prior, second-round draftee QB Kevin Kolb had inked a 4-year, $4 million with the Eagles.

So, JaMarcus Russell isn't really being a jerk by not signing, it's just that he doesn't know what his true value is because -- until co-first rounder Quinn signed a 5-year, $20 million contract -- Russell had nothing of semi-close value to which to compare himself.  My guess is that Russell will sign in the next week.

As always, the fun part is tying this together.

BNP Paribas (and other funds worldwide) are making like NFL draftees.  Because there are no buyers for sub-prime or Alt-A mortgages right now, it's impossible for the funds to know what their holdings are worth. 

Are the home loans in their portfolios worth JaMarcus Russell money?  Brady Quinn money?  What about Kevin Kolb money?  Or -- maybe! -- they worth last-QB-selected-in-the-draft Tyler Thigpen money.

Unfortunately, we can't even come close to answering those questions until a buyer steps up and starts "signing" loans. 

As soon as the first buyer puts a "market value" on a specific type of sub-prime or Alt-A loan, a number of positive things will happen:

1. Funds will re-value their holdings and begin allowing withdrawals again
2. The sub-prime and Alt-A mortgage product menu will expand a bit
3. Wall Street will relax a bit

Until that buyer shows up, though, mortgage money will stay out of the market like JaMarcus Russell stays out of training camp.

(Images courtesy: Brady Quinn Online, Rocky Mountain News)

What It Won't Mean To Your Mortgage Rate If The Fed Lowers The Fed Funds Rate

I have fielded three separate questions from clients on the topic so that must mean it's time to address the issue in public.

The Fed does not control mortgage rates.  The Fed controls the Fed Funds Rate.

The chart above from HSH Associates shows the path of the Fed Funds Rate (in brown) against a few mortgage products since June 2004.  If there was a direct connection between FFR and mortgage rates, the chart wouldn't show the brown line playing catch-up.

The Fed Funds Rate is a short-term interest rate and its function is to make money more costly to borrow or less costly to borrow for homeowners and business owners.  This works because many bank loans are based on Prime Rate (which is 3.000% higher than the FFR).

As FFR goes up, so does Prime Rate.  And, as Prime Rate goes up, so does the cost of borrowing money.  The reverse is true, too, if FFR drops. 

Nowhere, you'll notice, do we mention mortgage rates in connection with the Fed Funds Rate.  That's because mortgage rates are based on the mortgage-backed securities market -- a global exchange similar to the NYSE or NASDAQ.  The Fed doesn't operate in these markets.

Mortgage-backed bonds are considered long-term products and pricing is based on long-term expectations of the U.S. economy and the U.S. dollar. 

What Trader Joe's And Yogurt Taught Me About Home Loan Scarcity

A favorite question from my clients is "Should I lock my mortgage rate, or should I float my mortgage rate?"  I am firmly in the "Lock Now" camp and have written about this more than a few times.

My standard answer to the questions has lately taken a different spin, though.  I still recommend locking a mortgage rate as early as makes sense, but I am now making the recommendation for a different reason.

In short, lock your rate today because there's no promise that the mortgage product you want will be available tomorrow. 

The market is shearing products like sheep right now.

Six months ago, my clients fitting the descriptions below would have been fine.  Today, their product options are dwindling fast and -- in some cases -- are gone.

• Foreign Nationals / Residents of Ireland, Scotland, England and Europe
• Self-employed businessmen and women
• Holders of home loans greater than $650,000
• Credit scores below 680 and weak assets
• Commissioned salespersons
• First-time home buyers
• Owners of investment properties

Fewer choices means having less chance of finding the "optimal" product for mortgage planning purposes.  Settling for something else will usually transate into higher cost of carrying, higher loan fees, or both.

So, maybe you read me every day, or maybe you found me from the CBS MarketWatch article posted Friday.  Either way, we're friends now so let's talk about my breakfast.

To relate this to real life, I think about the time I went to Trader Joe's and found out that they no longer carried Fage Total yogurt.  What gives!

It turns out that there was an importing pricing dispute of some kind, the pirate-behind-the-register told me.  "We don't know when we'll get it back in stock," she said.  And I was pretty upset -- what if I never get the Greek yogurt again...?

Well, the dispute finally ended and Total was put back on the shelves.  By my count, it took about 4-6 months to work out the deal that brought the yogurt back into the U.S. market.

Now, to tie it all in. 

Would you believe that what happened with the yogurt is just like what is happening in the mortgage market these past few weeks? 

Because there are pricing disputes in mortgage products (e.g. "How much is a mortgage really worth?"), a bunch of mortgage products have been removed from the shelves until the disputes can be wqorked out.

And this is why I recommend locking.  If more questions arise about the worth of a mortgage in the coming days and months, more home loan products will be pulled and the financing options will shrink for those that need it.  The list above is just a starting point.

Eventually, this will all work itself out, but until markets can agree on what a mortgage is worth, we may all have to settle for Corn Flakes.

Barry Bonds and Mortgage Bonds: Are They So Different?

Matt Murphy, the man who caught Barry Bonds' 756th home run ball, is holding onto a valuable piece of babseball memorabilia. 

According to some, the ball could fetch as much as $500,000 in auction bidding.

If in the future, Barry Bonds is found to have used steroids, though, the value of Home Run #756 will drop dramatically. 

Most people get this concept. 

The ball's current valuation model is based on the premise that Barry Bonds did not use performance-enhancing drugs during his career.

If he did use steroids, however, the model used to price the ball today is flawed.  If it happens, we can only guess what the ball will really be worth.

This same line of thinking is what is causing mortgage markets to gyrate lately. 

The financial models that determined the "risk" in mortgages are now being proven to have been flawed.  And there is no history on which to base a new pricing model.

Until new financial models are tested and "approved", therefore, markets will continue to literally guess what mortgage bonds should be worth -- just like we'd have to do with a the-clear-and-the-cream-tainted Barry Bonds 756th home run ball.

Investor funds are trimming their overall risk exposure to compensate for the added risk of mortgage-related holdings.  And, until the broader market defines what a mortgage bond is worth, many investors are trying to stay as cash-heavy as possible. 

This is one reason why there is a global "dump" of stocks, bonds, and everything else.  Once the risk is finally defined, markets should regain their balance.

(Image courtesy: accessnorthga.com)

When Foreclosure Rates Drop, You'll See: Free Markets Can Outperform Government Legislation

Did you notice: 

In what took many state governments over 18 months (and counting) to "fix", "free markets" eliminated in three days.

Regardless, a few years from now, state legislators in Illinois, Minnesota and elsewhere will take credit for the reduced number of foreclosures in their home states, without even nodding to the real reason. 

They will say: "We stopped predatory lending with our new laws!". 

Guys like me will say: "No, Wall Street just stopped providing money to homeowners most likely to default."

Foreclosure rates will be down across the country in the years ahead and it won't be thanks to state-by-state mortgage legislation.  Foreclosures will be lower because hedge funds, big banks, and global investors are getting really tired of selling their $100 million loan pools for $93,000,000.

The Quick Snap Back To 2002

All around me, I hear screams of panic.  Some with merit, most without.  Yes, the mortgage market turned sour in a very big hurry, but credit standards are still looser than they've been historically and there are plenty of homes for borrowers-in-need (pardon the pun).

The products getting flushed right now are the high risk loans that would never have had a prayer six or seven years ago.

Check out the two charts above (grâce à Kit Mueller).  The top chart shows how loans were split on a dollar-for-dollar basis in 2002.  The bottom chart shows last year.

In the current market, sub-prime and Alt-A loans are history so it's likely that we'll snap back into some 2002-like form until debt issuers can figure how to properly price risk.

After that, it should be a slow crawl back for the sub-prime and Alt-A markets.  But rest assured -- so long as there are creative mathematicians on Wall Street, there will be debt instruments available for the tenants of Sub-Prime and Alt-A-ville.

It just may not be for a few months, or even years.

(Images Courtesy: Real Estate Charts)

Unless You Watch CNBC During Your Lunch Break, You Missed A Must-Watch Video

Earlier this month, CNBC featured a segment on how sub-prime mortgages work.  The shame of it, though, is that it aired at a time when the probable audience was already well-versed on the topic.

This would be like holding a seminar on how to throw a baseball to the attendees of the Baseball Hall of Fame induction ceremonies this weekend.  Chances are pretty good they already know how.

The folks that really needed to see this clip are the average homeowners of America. 

In 4-minutes-and-18-seconds, CNBC very clearly explains how losses in the sub-prime market are beginning to trickle up to into "prime" market.  And this aired before some major, major fireworks.

Since the original air date, the following "bad things" have happened:

• United Capital Asset Management incurs $500 million in sub-prime losses (July 3)
• Braddock Financial incurs $100 million in sub-prime losses (July 5)
• Bear Stearns funds incur $1.5 billion in sub-prime losses (July 18)
• Basis Capital Funds Management incurs "steep" sub-prime losses (July 20)

Big numbers, folks, and they are creating a larger fear about United States mortgage-backed debt on the whole.  Previously contained, the fear is now creeping out of sub-prime and into the 'tweener Alt-A market. 

If sub-prime and Alt-A loans keep throwing off losses of this magnitude, investors around the world will eventually stop buying the "Triple AAA"-rated stuff described in the video, too.  If that happens, whoa Nellie!

Watch the clip.  It's only four minutes long.

Source
How Credit-Market Tremors Have Affected Junk Bonds, LBOs and Hedge Funds
The Wall Street Journal Online
http://online.wsj.com/public/resources/documents/info-BondTurmoil0707-sort.html

What Went Down, Just Came Up

Yesterday was a favorable day for mortgage rates as average housing data and momentum trading carried bond prices higher.  Bond prices up, mortgage rates down, of course. 

Today, those gains have already been erased. 

The Bank of England's June 7 meeting minutes reveal that a rate hike may be imminent.  Sweden's Central Bank is telegraphing the same.  In response, money is flowing out of U.S. dollars and into the above countries' respective currencies.

A weakening dollar pushes bond prices back down and that is what is reversing yesterday's gain.

All things considered, mortgage bonds should not be moving as much as they are.  But, this is the summer season and in the summer, fewer traders show up for work. 

Especially during a week like this one in which there is no major data release. 

With fewer traders participating in the markets, there are fewer bond buyers to match with sellers, and fewer bond sellers to match with buyers. 

Therefore, it is much less likely that a person who wants to buy at a certain price will find somebody who wants to sell at a certain price.  Therefore, mortgage bonds (and interest rates) tend to move a lot more sharply during the summer than we're otherwise used to seeing.

Today, three Fed presidents take the stump:  Janet Yellen (San Francisco), Timothy Geithner (New York), and Richard Fisher (Dallas).  Markets will listen to the Fed speaker for clues inflation and the economy. 

If the speakers indicate worry over inflation, mortgage rates will rise in response.

Punxsutawny Phil And The Mortgage Markets

You didn't have to wake up to "I Got You, Babe" this morning to realize you've been living the same day over and over again.

Wake up, watch mortgage rates go higher, fall asleep.  Repeat.  Repeat.  Repeat.

Today, the mortgage bond sell-off seems tied to speculation that Bank of Japan will raise their overnight lending rate in the near future, although at this point, it's unfair to point to any one cause.

The mortgage bond market is a falling knife and nobody wants to catch it -- they all just want to get out of the way.

As of 9:45 CT, mortgage bonds are off 44 basis points and appear headed lower.

Update (3:30 CT): Mortgage bonds are off 78 basis points on weak demand for U.S. treasuries.  You almost wish for economic data at this point to at least give traders something to hold onto.  We are in a pure psychological play at the moment.

Who Would Have Thought That The Cubs Could Teach Us About Mortgage Bonds?

I just finished up a call with a client in which we discussed the current state of mortgage markets and why mortgage rates have risen so far, so quickly.

30-year fixed mortgage rates are up as much as 0.625% over 30 days.  That's ridiculous given the relatively low volatility of mortgage rates since last August.

Unfortunately, most folks have no context or perspective of the mortgage markets so the job gets left to people like me to help put market changes into plain English terms.

I just explained it to my client like this:

Mortgage bonds are the Cubs and global investors are the Cubs GM Jim Hendry realizing that the Cubs won't make the World Series.

He understood me perfectly.  Here's how it goes. 

The Cubs organization invested millions of dollars in the team during the off-season, signing Soriano ($17 million), Ramirez ($15 million), DeRosa ($4.3 million) and others. 

The hope was that the investment in players will bring a championship.

Expectations were high for the Cubs but those expectations are not translating into on-field performance.  After all, it's mid-June and the Cubs are sitting 6 games out of first with a .448 winning percentage.

So, Cubs GM Jim Hendry faces a familiar problem.  Fish, or cut bait?

Clearly the Cubs don't have the pieces to win a World Series without making a trade (or several of them), so Hendry's choices are:

1. Double down on the off-season bets by trading Cubs prospects for "now" players
2. Or, abandon the off-season plan by trading expensive players in exchange for prospects and a new plan for the future

Did you see the talk of Carlos Zambrano getting shipped to greener pastures?  This is where my client had his Eureka! moment.

Bond markets are facing the exact same problem as the Cubs management.

See, for the past 9-12 months, bond markets were planning for a fantastic "season" in the U.S. economy.  They loaded up on product and hoped for fantastic returns.

Flash forward into Q2 and with each passing news release and with each different Fed speaker taking the podium, it's becoming apparent that the market's collective assumption was wrong.

For a long while, traders held on hope that the economy would pull it out, validating their investment.  It's only now that they realize how they miscalculated.  And nobody wants to be the last one holding their "stars".

Traders are unloading their portfolio in order to protect their future cash flows.   Much like the Cubs will do soon with Zambrano.

(Images Courtesy: USA Today, Major League Baseball)

Housing Data Becomes Irrelevant As Sector Decouples From Mortgage Bonds

The National Association of REALTORS has changed their 2007 housing forecast for the worse, as reported by CNNMoney and other news sources.

Four weeks ago, this would have been terrific news for mortgage rates shoppers.  Today, not so much. 

Mortgage rates are only slightly improved on the day.

Why?  Because the housing sector is decoupling from the mortgage-backed securities market. 

Despite ongoing weakness in housing, consumer spending surges ahead.  It's now apparent to markets that housing will not slow down the economy as the Fed had predicted (and communicated) in its four press releases earlier this year.

Just yesterday, in fact, Fed Chairman Ben Bernanke alluded to the monetary policy-setting group's reduced focus on housing, stating that inflation risks "remain to the upside." 

For a succinct breakdown of NAR's second revision to its 2007 forecast, check out Inman Blog's bullet-point comparison.

(Image Courtesy: Strangeland.com)

Mortgage Bonds Get Bloodied. Again.

Three steps:

1. Re-read the headline
2. Re-read this post
3. Lock your rate already

Mortgage rates are now at a 10-month high.  Just yesterday, it was seven months.

It Took 17 Years, But Milli Vanilli May Have Been Right

I haven't seen carnage like this since Rob and Fab's career.

In the past 14 days, mortgage prices have given up close to 70 basis points.  Rates are up by as much as one-half percent.

There are a lot of reasons for the rapid spike in mortgage rates so pick your favorite two or three from the list below.  Amaze your friends at parties.

• Mortgage bond prices have moved below their 200-day moving average and program trading is adding to the sell-side pressure
• The dollar is off against almost every major currency
• Oil refineries are cutting supply, pushing gas prices higher
• Fears of wage inflation are supported by strong jobs data
• Forecasters are predicting an active Hurricane Season this year.  Milli Vanilli may have been right after all.
• Richmond Fed President Lacker says that the Fed may not be doing enough to stop inflation
• Central banks around the world are raising their respective interest rates, attracting buyers that may have otherwise bought US-dollar denominated securities such as mortgage bonds

Despite all of this, there may be chance that mortgage bonds are oversold.  This means that there could be a quick bounce/retreat in rates sometime soon, but there's no sense gambling on it. 

Get in and get locked, folks.  Floating a rate is too risky a proposition for most homeowners.

How Wage Inflation Concerns Do A Number On Mortgage Rates

Because of technical trading factors, prices on mortgage bonds plummeted last week, dropping more than 50 basis points overall.  Mortgage rates are now at their highest levels in several months.

And, unfortunately for home shoppers, it looks like the trend will continue for some time.

Traders took special notice of last Thursday's Initial Jobless Claims figures.  Normally, this weekly release is as much of a non-event as a Purdue-Indiana football game. 

But this week's surprising strength dropped the one-month average of Americans filing for unemployment to a one-year low.

This is the now the third of three major data points that may be pointing to wage inflation in the US:

1. New unemployment claims are at their lowest rolling average in a year
2. The unemployment rate's steady decline continues
3. Hourly workers are earning more money for their labor

Here's why wage inflation concern markets:

More people working means higher costs for business.  Eventually, those costs get passed on to consumers (who ironically don't really mind/notice because they're taking home a bigger paycheck).

So, consumers pay more for everyday items but that higher cost is offset with their higher income. 

More dollars to buy the same goods -- this is inflation in action.  In an inflationary environment, each dollar is worth less versus the value of the item being purchased so it takes more dollars to buy the same item.

Inflation is universally bad for mortgage bonds because mortgage bonds pay out to investors in U.S. dollars.  When the dollare are "less valuable", the demand for the bonds drop and with reduced demand comes higher rates.

This Thursday, we'll see where Initial Jobless Claims registers.  If it's less than 305,500, that moving average will drop again.

(Image Courtesy: Purdue University)

Why Psychology > Data This Week In Mortgage Rates

For just the second time in two years, the tide in mortgage rates has shifted discernibly.  Unlike last time, though, the news is not good for mortgage shoppers.

We talk about it a lot: mortgage rates are not picked from thin air.  Just like stock prices, they are based on facts, opinions, and psychology.  There is always data to interpret but, for the first time since last Fall's precipitous decline in rates, psychological factors are now the driving force. 

In trading circles, it's called "technical trading" and it can be a powerful force.

Technical traders don't watch data; they watch patterns.  This is very different from "fundamental traders" that make decisions based on numbers and politics.

Both philosophies have merits to and are legitimate so we must pay attention to both of them when trying to predict future mortgage rates. 

As my regular readers know, I prefer to discuss markets from a fundamentals perspective because it's more interesting to me.  I like breaking down world events into plain English and explaining how they tie into home financing.

Technical trading, though, however cold and robotic it may be, is always in the back on my mind.  That's because if you turn your back on the technicals for even a moment, you could get stabbed in the scapula.  The markets move fast.

This week is a terrific example. 

Mortgage rates have eroded quickly since Tuesday afternoon as technical traders react to a chart mapping mortgage bond prices over time.  According to the chart's pattern, mortgage bond prices should continue to drop in the future and -- rather than be the last one to sell -- traders are selling now before prices get really bad.

Lower bond prices = higher mortgage rates and that is exactly what we're seeing now.

If you're shopping for a mortgage, today would be a good day to lock.  For now, the trend is not your friend.

More Ups and Downs Than An Elevator

Mr. Deeds: [Stepping into an elevator] So how's the elevator business treating you, Reuben?

Reuben: It has its ups and downs.

---

Up and down.  Up and down.  Up and down.

It's been a stomach-dropping ride over the past two weeks for mortgage rates, mostly because traders can't find the answer to the most important question facing mortgage markets:

Are in the midst of inflation, or not?

Everytime we see strong data in one sector of the economy, there is weak data to offset it somewhere else.  This week's tame Consumer Price Index, for example, showed that maybe prices aren't increasing as fast as expected.

So, what's a regular dude to make of it all?

If you're rate shopping, it may be better to just lock in your rate today and hope that rates don't drop.  Rates have been so erratic that waiting even one extra day can cause your mortgage rate to jump by as much as 0.250%. 

We've seen that twice in the past three weeks.

There's no significant economic news until the middle of next week, but outside market forces such as politics and/or oil always have the ability to jolt mortgage rates.

Unlocked Mortgage Shoppers Are Screaming Today

If you were floating your mortgage rate overnight, there is some bad news coming out of the trading pits.  Mortgage rates are getting killed this morning.

Low trading volume related to Good Friday generated extreme reactions to this morning's Non-Farm Payrolls.  When the jobs report showed 180,000 new jobs created -- a hot number by any standard -- the reaction was swift and decisive. 

Mortgage bonds are off 22 basis points and it's not even 10:00 A.M. on Wall Street.  The carnage won't be limited to just today, either. 

The stock market is closed today so when it re-opens Monday, capital will want to flow into stocks based on the perceived strength of the economy.  Some (most?) of those dollars will come from the bond market and that will place further downward pressure on bond prices.

When bond prices go down, their yields go up and yields = rates for those new to the game.  Markets close at 1:00 P.M. ET today so get your locks in quickly.

Update (10:07 A.M.): Mortgage bonds are now off 29 bps on the day.

The Fed's Secret Weapon

Ben Bernanke told the congressionals Joint Economic Committee that inflation is "somewhat elevated", but it's no reason to expect a rate hike.

In his prepared statement, Bernanke said a lot of things, broken down as follows:

• Economic growth has slowed because of a "substantial correction" in the housing market
• Sub-prime industry problems are self-contained (so far)
• Business spending will pick up this year
• Consumer spending will propel the economy forward
• Inflation is down largely because of energy costs are down

The Fed sets the Fed Funds Rate for the United States and, typically, as FFR increases, the rate at which the economy slows down increases, too.

But, the Fed also has a "secret weapon" to slow down the economy -- worms words.

Every time a Fed official speaks in public, there are countless people dissecting every sentence, phrase and nuance, trying to plan their next move for business or investment.  In this respect, the Fed can creates expectations in the market and that can slow down (or speed up) inflation without technically "doing" anything.

Today's testimony is relatively neutral news for mortgage shoppers -- mortgage rates are unchanged on the day because most of what Chairman Bernanke discussed was already known and priced into mortgage rates.

Why Money Left Stocks And Got Picky About Bonds

This graphic from the Wall Street Journal shows last week's losses across a few of the world's major stock markets.

Money leaving stocks has to go somewhere and investors have two choices:

• Hold the money as cash
• Invest the money in bonds

Usually, investors don't want to be on the sidelines.  So, they will often take the proceeds of a stock sale and use it to purchase bonds.

Remember that mortgage rates are the by-product of prices and yields in the mortgage-backed securities market.  When demand for bonds increase, it drives up the price and drives down the yields.

This is why rapid stock sell-offs often lead to lower mortgage rates.

This past week was a little bit different, though. 

Despite the worldwide losses, mortgage rates decreased only about 0.04% on average, according to Freddie Mac's weekly survey.

The benchmark 10-year treasury note, however, dropped 0.165%.  This is the biggest gain in over five months for the treasury market.

Investors chose to park their money with the U.S. government last week and that reminds us that one very important fact about the oft-confused bond markets:

U.S. treasuries and MBS tend to move in the same direction, but treasuries cannot be used as a predictor of mortgage rates, nor can they be used to price mortgage loans.  Only the mortgage-backed securities market can be used to price mortgages.

One major reason why treasuries excelled while MBS markets laid flat is because investors are concerned that sub-prime lending's carnage will spill over into other mortgage markets.  That renders mortgage-backed bonds much more risky than in weeks and months prior and, in a period of volatility and uncertainty, the markets turned to Washington D.C. for safety.

Source
Out of Stocks, And Into...?
E.S. Browning
Wall Street Journal Online, March 5, 2007
http://online.wsj.com/article/SB117304961563826411.html?mod=home_whats_news_us

Homeowners With More Lives Than Rulon Gardner

If you're a homeowner with a mortgage originated sometime in mid-2006 and you haven't yet remortgaged it, you have more lives than Rulon Gardner.

After yesterday's stock market meltdown, mortgage rates are hovering around their nine-month lows.  Again.

This is now the fourth time since November that mortgage rates have yo-yoed to a range that make remortgaging a sensible solution for a lot of homeowners.  Each time, the window closed quickly and rates bounced back higher.

The pattern seems to be sticking today, too. 

Already, markets have erased most of yesterday's gains on the heels of in-line data about the economy, a Bernanke's repeat of his original testimony to Congress two weeks ago, and a general psychological recovery among global traders.

And, as a side note in the Rulon Gardner story:  Did you see the part of the story about where he is training to get his pilot's license? I think I like my chances better flying Oceanic 815 than on this guy's plane.

(Image Courtesy: Katsumi Kasahara / AP)

The Timing of Bernanke's Speech

The Dow Jones Industrial Average shed 416 points today, registering its biggest one-day decline since September 17, 2001.

With markets already on edge, Ben Bernanke's scheduled speech tomorrow carries an added dramatic twist.  The chairman's words will be closely monitored by the markets so expect volatility throughout tomorrow's session, too.

Mortgage rates benefitted late in the day today as investors moved their money broadly into bonds of all kinds.

(Image courtesy: Reuters)

Why The Stock Market Drop Is Not Moving Mortgage Rates

So far today, the Dow Jones Industrial Average is down more than 200 points and trading curbs have been put into effect.  This is good news for mortgage rates.

If stock markets were the Oscars, we'd have seen about fifteen Jack Nicholson reaction shots by now.

When stocks markets drop suddenly, investors want to stem their exposure to a reeling market so they sell some of their position(s). 

When an investor sell stocks, he gets cash in return for the sale.  The investor can then choose to keep the cash, or buy something else.

Not wanting to be out of the market entirely, an investor will usually buy bonds because the rate of return is a known quantity and because bonds tend to be less risky than stocks.

When demand for bonds increase, the price of bonds go up.  Higher bond prices drives the bond yields lower and that spills over into most bond markets, including mortgage-backed bonds. 

Most mortgage rates are rooted in the mortgage-backed securities market and this is why stock sell-offs usually lead to drops in mortgage rates. 

Currently, rates are on the verge of an intra-day re-price for the better but, as Phil Leto reminds us:

When rates decrease, they take the stairs.  When rates increase, they take the elevator.

If the situation were reversed in the stock market, mortgage rates would have repriced several hours ago.

Monday Market Notes