Tuesday, December 22, 2009

More on FED Suppressed Mortgage Rates

Finished up at work today. I am off until January 4th 2010!

Posting may well be weak this week. I have plans for tomorrow evening and then Christmas Eve is gift night, then it is Christmas Day and I have no idea what I will be doing as yet. I will have more material after the holiday.

GDP is a Backward Looking Indicator Anyway
I am in the same boat as Kid Dynamite tonight:
I continue to be amazed by the market's non-reaction to these revisions. Initial Q3 GDP was expected to be around +3.2%. When it was reported at 3.5% on October 29th, it set off a 70 point rally in the S&P 500 - from 1040 to 1110. Yeah! Our economic rebound is taking hold! Things are getting better! Green shoots! (imagine those last few quips were written in sarcasm font). On November 24th, the first revision to the report came out, "in line with consensus estimates" at +2.8%, and stocks didn't care. Somehow, the consensus estimates had managed to be lowered to 2.8% without anyone noticing or repricing the market to account for the downward revisions in estimates.

So the news was the shrinking GDP number for the 3rd quarter. Starting at 3.2% the number after all the data was in settled at 2.2%. I always get a laugh when the markets pull this kind of thing. Here is my best summary of the thinking:
"Well we bid up stocks with that print of 3.2% because, well, it was a good number. The first revision was down to 2.8%, and that is hardly any different so we bid up again. Today we find out that we were wrong on all counts, but hey, the 3rd quarter is long gone and that number is a backward looking indicator anyway. Plus imagine how huge the 4th quarter estimate will be! Carry on!"

More on FED Suppressed Mortgage Rates
The impact that the FED sponsored MBS purchase program is having on mortgage rates may well be the most contested issue right now. Estimates vary from no impact on rates to over a 2% suppression. Nobody seems to know for sure. Today there was plenty of coverage so I wanted to take another look.

Richard Green's blog spotlighted a paper written by John Taylor which makes a case that the FED MBS exit will have almost no effect on mortgage rates.

Calculated Risk thinks the MBS exit will have a minimal effect on rates, and once again sticks to his guns about the Spring exit and a bump in rates of 35-50bps.

I will start here because this is important.

If the FED buying MBS like it was going out of style (it has by the way) could only effect a 35bps change in mortgage rates, then it was a spectacular failure. As in MEGA SPECTACULAR. The gain in home sales from a paltry 35bps rate reduction would be minimal and for 1.5 Trillion it would have been criminal. Now I understand that the writers of the posts above have forgotten more about economics than I will ever know. I still think they are very wrong here. You have to ask yourself why the FED thought it so necessary to buy 1.5T of MBS if the markets were more or less working within 35bps of perfect. You will not need charts and no models are required. Give up?

It is because the FED knew (maybe they got the info in a Goldman Sachs conference call?) that real banks would not touch these instruments for anything near a 5-6% mortgage rate. The FHA/Fannie/Freddie black holes were all to glad to buy them all at that level, but whats sticking the taxpayer again between friends?

Higher estimates exist, though they are few in number. From CNBC comes an estimate more in line with my own from Mark Goldman:
"The ending of the Fed program will definitely effect rates," says Mark Goldman, professor of real estate at San Diego State University. "So far, the Fed has not expressed interest in keeping the program going. That could raise rates by some 150-200 basis points."

200bps vs. 35 bps

Extrapolate that out to a mortgage example:
FED Suppressed rate = 5%
Mortgage on a 200k home = $1000
Mortgage on a 400k home = $2000

Mythical Non-Suppressed rate = 5.35%
Mortgage on a 200k home = $1070
Mortgage on a 400k home = $2140

Real Non-Suppressed rate = 7%
Mortgage on a 200k home = $1400
Mortgage on a 400k home = $2800

I think you can see the picture here.

My call is for rates to move up 200bps or MORE after the FED exit. Of course I do not think for one minute this program is going to end in the Spring. I would hope that when the FED extends this program the same writers so quick to give the benefit of the doubt to the FED will change their tune.

Mathew Padilla of the Mortgage Insider offers his take and this observation:
When these programs end we should expect to see mortgage rates rise. Conventional wisdom is they could increase anywhere from 25 to 75 basis points. (There are 100 basis points in one percent.)

The reality is if they rise by more than say 50 to 75 basis points I would expect the Fed to start buying again (and maybe Treasury too).

What if the FED does exit and rates move 35bps or less? I will eat my words and do a full post apology for my totally wrong call.

Have a good night.


watchtower said...

Let me say this first, I am not a financial brainiac, so I may not be understanding this correctly.

First off, I was led to believe that the bond market sets mortgage rates and not the fed?

KD has a post up today showing a 30 year bond chart that could be construed to indicate a 6.7 - 7.0 % yield in the future.

This is one of those tech charts that I admit I know next to nothing about but it seems to have worked KD up in a lather:

"The impact of this sort of move on home values will be catastrophic. A move from today's rates to the 7s will instantaneously subtract a further 25% from the value of every house in this nation. It will do similar things to commercial property values. In addition such a move would likely more than double government borrowing costs, shutting off government "borrow and spend" attempts almost immediately."


I guess what I'm asking is who really sets the rates?

(No I'm not being factitious, I really am confused)

watchtower said...

Never mind, I think this kind of explains what I was asking:

The Message of the Yield Curve
by Gary Dorsch | december 22, 2009

"The yield spread between 2-year and 10-year notes reached +280-basis points and was last near these levels in 1992 and 2003. In both instances the economy was pulling out of a nasty recession and staged a sustained recovery. However, on both occasions, the Federal Reserve wasn’t bullied by the yield curve traders and waited for about a year before it grudgingly began to hike the federal funds rate."


getyourselfconnected said...

"The Market" does set rates in normal times, but of course these are not normal times. My market price for MBS is 150-200bps higher. Right now the FED is buying everything at induced lower rates in an artificial environ (FED backed paper = lower rates because default risk is on taxpayer). Yet another problem with manipulation.

watchtower said...

Thanks GYSC!

Lisa said...

The market sets the rates, period. Please repeat this to yourself until there is no doubt: The Fed is not all powerful and cannot "print" money for another year. There may be an historical equivalent to what has happened over the past decade, but the response is unprecedented. Especially the fraud and corruption that has occurred in the last year. Reality trumps whim, reality trumps whim, reality trumps whim. The Fed cannot start buying again without defaulting on our debt.
Bernanke has screwed up this shit so badly, it's going to take a decade of hard work, clean politicians, and dedicated Americans to regain our republics stature. It will happen, of that I have no doubt.

Anonymous said...

Surely many of you who troll the Internet blogs note the reoccurring theme that "this subterfuge can't go on much longer". Only it does. And then, instead of the gigantic implosion we were assured the situation morphs and there are newly issued calls for imminent catasrophe.

My intention here isn't to mock the skeptics, rather it's to encourage them to stick to the facts.

Exactly how does the FED manipulate equities, bonds rates, PM's. Is it HF trading and hedge funds ramping up the stock market?
How can QE counter China's reduced bond appetite? Who specifically causes those frequent significant drops in PMs at the end of London trading hours?

Details count. Let's turn the spotlight on the financial oligarchy and catch these cockroaches in action.

Anonymous said...

I think that the main purpose of the FED buying MBS was just to overpay for them as a continued back door effort to bail out the banks. Any rate reduction was gravy.

getyourselfconnected said...

Like I said the market sets prices usually, but they are content to sit and allow the FED to botom rates as long as they are buying this MBS crap.

great points.

sedentary state said...

>Today we find out that we were wrong on all counts, but hey, the 3rd quarter is long gone and that number is a backward looking indicator anyway.

Party on Wayne!
Party on Garth!

getyourselfconnected said...

"No Stairway!? Denied!"

GawainsGhost said...

Merry Christmas, GYC. Give my best to your family.

You too, Lisa. Watchtower, and all the other regulars.

Peace on earth, and good will toward men.

Dave in Denver said...

These people speculating on the effect it will have when the Fed stops buying crap assets and attempts to remove the stimulus are beating themselves off to dry orgasm. It will be impossible for the Fed to reverse its balance sheet, especially the Level 3 assets. There is no bid for that shit and it/I suspect the Fed paid face value for a lot of that shit. That's one of the reasons the Fed is going to any lengths to avoid an indepedent audit.

getyourselfconnected said...

Home late, but I will have a Christmas post 2morrow. Night all.

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