March 30, 2010

And If Rates Jumped Two Points? They'd Still Be Historically Cheap.

"Fixed mortgage rates likely will rise less than a quarter of a percentage point in the next three months, the smallest increase for the second quarter since a drop in 2005, according to estimates by Fannie Mae and Freddie Mac. The gain would add about $30 to the monthly payment for a $250,000 mortgage."

Cheap Mortgages May Last as Investors Replace Fed [Bloomberg]

First Published: March 30, 2010 2:40 PM

Comments from "Plugged In" Readers

warning--old boring story coming:
My ex and I bought our first house with a 13 percent VA mortgage (one point below market rate) in 1981. Any single digit mortgage rate seems cheap to me.

Posted by: old timer at March 30, 2010 4:36 PM

250k @ 5%, 30y = $1342
250k @ 5.25%, 30y = $1381

250k @ 6%, 30y = $1500
250k @ 6.24%, 30y = $1540

Seems closer to $40 to me.

Posted by: eddy at March 30, 2010 5:36 PM

My guess is that in 3 months mortgage rates will be where our benevolent leaders want them to be. our market has already told our leaders that housing can't survive with "sky high" 6% rates, so it wouldn't take much to convince me that our leaders will make sure any mortgage rate rise occurs slowly.

As Fed intervention wanes, if the private sector can keep mortgage rates where the Fed wants it then it's good news for the mortgage market. If not, the Fed has already told is it will simply restart MBS purchases.

in other words: we'll have whatever rates Bernanke/Obama/Pelosi/Hu want us to have, whether it is through private means or Govt intervention.

they're just going more covert, that's all. For instance: I wonder what they're doing with that revived $200 billion Treasury Special Financing vehicle again??? And what are they doing with those lifted caps on Fannie/Freddie loan losses? what has the Fed been doing with all it's 4 letter facilities?

I'm certainly interested in what happens this summer!

but I agree, it is unlikely we'll get a mortgage shock this summer. Instead, I foresee rates going up about 0.5% or so. any more and mama govt will run in to bail out the banks/mortgage investors.

Posted by: ex SF-er at March 30, 2010 7:37 PM

addendum:
all this assumes that the bond vigilantes don't squawk.

there are some very strange things going on in the bond market right now.

The swaps spread is negative right now, but nobody knows why. It's not for the typical reasons and seems to not be a good development. it may be a harbinger for possible rise in the 10 year Treasury going forward. This of course would affect many fixed mortgage rates.

also, the flood of Treasuries is starting to cause a little indigestion in the bond market... more supply of Treasuries might mean lower prices, which means higher yield again... which may push mortgages up.

On the other hand, there are major problems with some sovereign debt markets. (e.g. Greece). If strains show up in the PIIGS market or god help us the Euro or another wild card, then it could cause fear and a "flight to safety" leading many people to rush towards Treasuries... which could drastically increase Treasury prices, lowering their yield... leading to lower mortgages.

so as you see, this stuff is complicated, and I don't know that anybody's crystal ball is working right now.

I still think the Fed/govt will do everything in its power to keep mortgages low, but much may be in stealth, and the Fed/govt although super powerful isn't omnipotent and could be over-run by some of the above factors.

Posted by: ex SF-er at March 30, 2010 7:58 PM

old timer wrote:

My ex and I bought our first house with a 13 percent VA mortgage (one point below market rate) in 1981. Any single digit mortgage rate seems cheap to me.

Yeah, but you probably got a 12+% raise that year to catch up with inflation, assuming you had a job. Same thing for 1982, 1983, 1984, 1985. In 1985 this mortgage felt at least 40% cheaper than in 1981. And the idiotic prop 13 did the same thing for your property taxes.

There hasn't been any inflation for many years. Many 30-somethings would feel lucky today to be paid 12% more than they were in 2005, even 2000. When you're mortgaged to 50+% of net salary and neither inflation nor appreciation nor a pay raise will bail you out, 1 or 2% matter a lot.

Posted by: lol at March 30, 2010 10:31 PM

Ex-SFer - if the swaps spread is negative, doesn't this create a sure-win arbitrage opportunity ? In other words, you could simultaneously buy for $50 and sell for $52 for example ? I'm sure I'm misunderstanding this.

Either that or I'm gonna be rich.

Posted by: The Milkshake of Despair at March 30, 2010 11:49 PM

ROFL. Great comment, made me laugh

The only sure win arbitrage opportunity right now is to be a banker. Gamble the markets. If your bets win it's bonus city. If your bets go sour then the govt will bail out your firm and you get an even bigger retention bonus. You know: we don't want those big banks to lose their "talent".

Undoubtedly in normal times this would be a great arbitrage opportunity. However these are not normal times hence we have the negative spread. We have a lot of multinational governmental interference in these markets, and also a lot of dangerous leverage and speculation in the market, not to mention gambling zombie banks. A negative swaps spread has happened before (in 2008 when Lehman collapsed), but the conditions are different this time.

who knows how long this situation will last? as they say: the market can stay irrational longer than you can remain solvent.

Clearly there are a lot of big money banks that are sweating bullets right now because of this. (there is no way in God's green earth that they positioned themselves correctly for this). this could precipitate another crisis if it lasts much longer.

On a side note for those of you who don't know: negative swaps spreads were considered a mathematical impossibility up until late 2008 when it happened the first time. now it's happened again! ROFL.

To show you the ridiculousness of the negative swap spread:
-it is basically saying that the default risk of the US Government is HIGHER than the default risk of the big banks. Got that? The banks, who are only living BECAUSE OF the Government, have a lower default rate than the government itself!!! hahahahahah. that's the dumbest thing ever.
If Citigroup or JPMorgan or even Godman, oops I mean Goldman, defaulted right now, the US Govt would survive.
If the US Government defaulted right now there is NOT ONE single bank in the US that would escape, and few to possibly none in the Western world. Many of the biggest banks are DIRECTLY supported by the US Govt. Most of the rest have huge exposures to Treasuries, Fannie, Freddie, Ginnie, FHA, Federally insured student loans, etc. All that would be wiped out with a US default.
Dumb.

so there are a few possible ouctomes:
-Treasury yields rise which will improve the negative spread situation (helping the banks that are surely upside down on that trade), but hurt the nascent "recovery" we've been having (by pushing up fixed mortgage rates and anything else tied/linked/related to 10 year Treasuries) which may hurt the banks based on their mortgage securities held at mark-to-fantasy valuations

or
-The govt continues to hold Treasury yields low, which exacerbates the negative spread situation, but will help the mortgage rate situation.

or
-one of the big banks blows up based on the negative swaps spread causing another financial crisis

or the modus operandi of the BushObama administration:
-extend and pretend, and pray fervently that they can slowly increase Treasury rates without hurting the nascent recovery, and buy enough time so that the banks can somehow earn their way out of yet another mess they've gotten themselves into.

Posted by: ex SF-er at March 31, 2010 8:01 AM

If you are unhappy with the Big Banks, you can always bring your business somewhere else. Right now they don't care about their real customers. Move to a smaller more local bank. They'll care more for you.

Posted by: lol at March 31, 2010 8:47 AM

Ex-SFer - Are you saying that the default risk could occur in the interval between the buy and sell, leaving the swap holder with a worthless or severely devalued asset ?

I have no experience buying/selling swaps and don't even know whether they're available to a retail investor. So if there is a long minimum holding period required then I can see how the default risk could become a factor. Kind of like those 5% CDs that WaMu was offering while their more solid competitors advertised only 2%.

Posted by: The Milkshake of Despair at March 31, 2010 10:30 AM

For what it's worth, I got an e-mail last night from yet another ex-employee who wants to come back to work for us. (We're negotiating with the first one, who is taking a 35% cut in pay from her job with a currently-teetering firm).

The second one left 3 years ago to go to grad school - MFA at UCSD. UCB undergrad with a 3.5+ GPA. She graduated last May and has been looking since then. No jobs. Zero. Zilch.

I was paying her $80K. She'd probably come back for $50K (down about 35%), but I probably won't extend her an offer because we don't really have the work that she likes to do. It's an Obamanation when UCB grads can't find jobs.

Posted by: tipster at March 31, 2010 10:31 AM

Luckily for the local and nationwide economy and housing market, the plural of Tipsters anecdotes is not data!!

Posted by: REpornaddict at March 31, 2010 10:40 AM

@tipster: Good example.

My only comment would be "...have the work that she likes to do". I like that one, only because it shows the arrogance of the average worker. She has no job, but can complain about the type of work that she may have to do. How times have changed. My dad worked on the docks, and I'm sure he would have preferred to do something else, but he was responsible and didn't want handouts....How times have changed (again).

She may eventually go on the government payroll, only to re-elect the incumbents that have been paying her. How twisted.

Its a sign of weak person to depend on someone else (i.e. the government) to take care of the majority of your needs. If I was ever down on my luck, I would find a job doing whatever, McDonalds even, because unlike most of the people in SF, I have a sense of pride.

Posted by: SFRE at March 31, 2010 10:48 AM


"unlike most of the people in SF, I have a sense of pride."

"But there you go again labeling people and stereotyping"

Both by you today, SFRE.

Posted by: sparky-b at March 31, 2010 10:54 AM

True. You got me there. I take away my label, it was wrong to do.

Posted by: SFRE at March 31, 2010 10:57 AM

A starving artist? Who could have predicted?

Posted by: J at March 31, 2010 10:58 AM

ex SF-er: Thanks for your informative posts. I wonder if you can help me understand the negative swap spread a little better. I initially thought this was the difference between 10-year bank debt and 10-year Treasuries, which would indeed be crazy. But a Bloomberg article I found said that it was the difference "between the rate to exchange floating- for fixed- interest payments and comparable maturity Treasury yields". Can this difference somehow explain what's going on?

Maybe there is some concern about counterparty risk or a desire to exchange one type of obligation for another that makes this investment more attractive than treasuries.

Thanks again for your insights.

Posted by: Po Hill Jeff at March 31, 2010 11:10 AM

An MFA? Not exactly a ticket to sweet high paying gig.

An anecdote from a conversation with a friend:

Friend: I need a job.
Me: Go get one then.
Friend: There's nothing out there that I want to do. My field has no jobs.
Me: Who said anything about that? I said get a job.

And some of my friends have done just that. You do what you need to do. God knows I didn't want to be cleaning the toilets of crappy mission apartments 7 years ago, but I was doing it.

Posted by: R at March 31, 2010 11:11 AM

To SFRE and others enjoying the kneejerk rants, at no point did tipster indicate this person is unwilling to work outside her field.

Go back and read what he wrote, and consider just how blinded you are by your biases.

Posted by: Delancey at March 31, 2010 11:52 AM

@Delancey: She doesn't have a job, does she? Been looking since last May? I'm sure if she broadened her search she'd find a job.

Posted by: R at March 31, 2010 11:57 AM

You guys are hilarious. Get young people to do work they don't want to do? Ha ha ha!

MFA (masters in fine arts for those of us less high fallutin' folk)? Why not? We were a rich society. And remember, she *walked away* from my $80K per year job (undergrad major was English) to get her MFA. I had to pay her $80K with an undergrad English major and even that wasn't enough to hold on to her! I think in the new, new economy, an undergrad English major gets $40K tops.

Sorry, they'll just elect Obama and he'll take care of everything. That's what I'm beginning to understand. He's doing all this socialist crap because that's what the people who elected him want.

Here's the thing I finally realized: every administration, doesn't matter if its dem or republican, has one purpose: make life better than it really is. So the trick is to find a group of people you can steal from who will a) put up with it and b) are a politically acceptable target to those who are the beneficiaries. In the 1930s-1970s, we had unions to steal from consumers. When consumers ran out of money in the late 70s (and the oil countries woke up and started siphoning more of our money away), the laws were changed to motivate more women to enter the work force to give consumers more to spend.

When that ran out of steam, Greenspan engineered bubble after bubble. You can hate the guy but it worked: I had to pay an English major $80K just to get her to show up to work. Stealing from future generations has become more and more acceptable, so deficits started to rise.

But bubbles are now too obvious to work, we've reached the limit of people's accptance of our robbing future generations and so what are the alternatives? Actually make people scrub toilets? Make union workers actually work and pay them what they are worth (NUMMI's last day is TODAY - they'll just lose their jobs rather than give up their dream of $100K salaries for a high school education)? No, the people aren't ready for that.

So we look to "the rich" and take their money away to give to the masses. We had to do something, because compared to the bubble years, reality is going to look very, very harsh.

The fact is, we've been engineering fake economies for the past 20 years, and before that it was just robbery, from everyone, a little at a time. I've socked away millions of dollars, but I only earned all that cash because of the fake economies we've been engineering. The fact that the clown in the white house has no further FAKE options and has to now actually start stealing money is really no worse. It was all a dream, a fake, that enabled me to earn so much money all along. So how can I complain when plan B is to steal the money I was only earning because of a series of bubbles?

Whatever happens, happens. I'm rich, so I've become the new politically acceptable target. It's what Hitler did to the jews, just a "bit" less extreme. People just aren't going to start scrubbing toilets like we would. They just won't. Get used to theft: it's all they have left. Republicans or Dems, they were not going to have this place looking like the dust bowl years of the 30s. It took ten years dig out of that mess. Is that really what we want?

And Delancey, I can assure you that SFRE is dead on in his assessment of her: she walked away from my $80K job to get her MFA.

Posted by: tipster at March 31, 2010 12:36 PM

@tipster: One of the best posts ever that I have read on SS.

Posted by: SFRE at March 31, 2010 1:13 PM

Yeah, it just sucks having money these days.

Ever notice how the lower the tax rate on "the rich", the more recessions/depressions occur?

When you are ever bored, take a look at what the top marginal tax rate was under Eisenhower, et al.

Posted by: J at March 31, 2010 1:39 PM

@J: What do you consider "the rich" (dollar figure please)?

Posted by: SFRE at March 31, 2010 1:46 PM

tipster,

That's a very US-centric view.

Global wage arbitrage is a big part of the current correction in wages. The bubble mitigated that for a while and that too did pass.

It's good to have a bit of real wealth these days. I hope inflation will stay where it is. With these lower salaries we should be OK for a few years...
The last thing you want to do is blow your money on overpriced SF Real Estate.

Posted by: lol at March 31, 2010 1:57 PM

Some analysts are saying rates could hit 5.6-5.7% due to the Fed ending purchases. That's based on historic spreads between 10-year Treasuries and mortgage rates. But I was also thinking it's possible that spreads could be higher than historic spreads because of higher risk.

Posted by: Anon E. Mouse at March 31, 2010 2:25 PM

tipster --

Leaving employment to pursue one's dream is not the same thing as being unemployed and refusing a job offer. You know that. Whether that dream is viable or not is irrelevant to the kneejerk rants about being willfully unemployed. Your original post was unequivocal that said unemployed person was not given a job offer.

Nice spew, BTW. I take back anything nice I said about you. You do seem to be of the mindset, "It is not enough to succeed. Others must fail".

Posted by: Delancey at March 31, 2010 10:08 PM

Another example of what is wrong with society , and goes to what a lot of have been saying on this thread:

"An unusual and much-heralded program that gave poor families cash to encourage good behavior and self-sufficiency has so far had only modest effects on their lives and economic situation, according to an analysis the Bloomberg administration released

The three-year-old pilot project, the first of its kind in the country, gave parents payments for things like going to the dentist ($100) or holding down a full-time job ($150 per month). Children were rewarded for attending school regularly ($25 to $50 per month) or passing a high school Regents exam ($600)."

Posted by: SFRE at April 1, 2010 9:29 AM

I initially thought this was the difference between 10-year bank debt and 10-year Treasuries, which would indeed be crazy. But a Bloomberg article I found said that it was the difference "between the rate to exchange floating- for fixed- interest payments and comparable maturity Treasury yields".

@PoHill Jeff.

I'm not sure that I would do a good job explaining the swap. but here goes (this is simplified and not completely accurate but the gist is correct):

Let's pretend you are an investor, and you own a variable (floating) loan, for example one that is indexed to LIBOR. This makes it difficult to do long term planning because you don't know exactly how much interest income you'll get each month, because you have interest rate risk. You'd rather have a fixed rate, like a 10 or 30 year Treasury.

You could then go to a private counterparty and trade your LIBOR-indexted variable loan for a fixed rate loan instead. this is called a "swap". you've swapped your variable loan for a fixed loan.

Typically, the swap will have a higher yield than a Treasury. The reason: because the Treasury is a guaranteed x% return and the likelihood of the US Government defaulting is negligible.
When you buy a swap, however, then you are dealing with a private counterparty which has a default risk higher than that of the US Government. so the extra yield compensates you for default risk.

Since the US govt is always less of a default risk than a bank, the swap spread is always positive.

but currently the interest you get on a swap is LESS Than the interest you get on a Treasury.

in other words:
investors have a choice:
earn x% in a Treasury
or LESS Than x% in a swap, backed by a private counterparty (like a big bank).

right now investors are choosing LESS than x% in the swap.

Nobody knows why. It doesn't make sense.

There are a bunch of yahoos out there talking about the US Govt defaulting on its debt. Ignore them, most of them are talking a political book and ignore the realities of economics. The US Govt prints its own currency, and therefore it is impossible to run out of money. There is almost no entity on Earth that has less of a chance of default than the US Government, so long as we can borrow debt in our own currency.

Besides, if the US Govt were to default, EVERY major bank would also default. So you're not protecting yourself from US default by buying a swap. (you'd need to buy gold or a hard asset or a different currency).

now, of course the govt can inflate the debt away... inflating the debt away is NOT default... even though it does reduce the real value of the security.
but inflating the debt away would inflate Treasuries AND swaps and anything else denominated in dollars. so goiong to swaps doesn't save you from inflation.

In other words there is no logical reason for the Swaps spread to be negative.
Anything that brings down the US will also bring down your private counterparty for the swap
Inflation will hit both swap and the Treasury.

so why exactly are investors paying a premium to buy a Treasury??? if you know you'll have to tell everybody.

hopefully this makes sense.

Posted by: ex SF-er at April 1, 2010 10:52 AM

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