Slumping mortgage activity ... questions about credit ... and thoughts on a SWF bailout that went awry

Good Wednesday morning to one and all. A few things I'm perusing at this hour:

* The Mortgage Bankers Association's weekly application index dropped 1.5% to 419.3. That is the lowest level for this gauge of home loan activity since December 2000. Purchases fell 0.4%, while refinancings dropped 3.7%. The MBA chart above really puts into perspective the rise and fall of the great refinance and home purchase bubble.

* U.S. Treasuries are on the move again this morning, with the long bond futures up about 11/32 as I write. Swap spreads are also a bit wider, as are mortgage spreads. We're right around some crucial levels here, closing in on what we saw at the time of the Bear Stearns-related panic. It'll be interesting to see if we can surpass those levels or if this area will hold.

* The Wall Street Journal does a good job of dissecting the capital concerns and market issues at Fannie Mae and Freddie Mac. Here's an excerpt:

"Both Treasury and the companies are in somewhat of a bind. The government is reluctant to intervene and had hoped to reassure markets by asking Congress for temporary authority to take an equity stake in the firms or loan them money.

"Meanwhile, Freddie's ability to raise capital, and therefore avoid a bailout, is constrained by the uncertainty created by the government's deliberations, according to people familiar with the matter. Investors are unlikely to buy new Freddie shares if they fear the government might mount a rescue that would hurt the value of those shares. Freddie executives are due to meet with Treasury officials Wednesday to discuss the situation and the two sides may explore whether the Treasury could clarify its intentions in a way that would reassure investors.

"Mr. Paulson asked for the authority as a means to reassure the markets that the government wouldn't allow the companies to fail. But the companies' share prices have continued to fall as investors fear that the two won't be able to avoid a government bailout. Fannie and Freddie own or guarantee more than $5 trillion of home mortgages or nearly half the total outstanding.

"The companies' increasing financing costs tend to push up mortgage rates paid by consumers. Mortgage applications are at their lowest levels since December 2000. For the week of Aug. 8, applications were down about 37% from a year ago, with purchase applications off 32% and refinance applications down 44%, according to the Mortgage Bankers Association.

"Two weeks ago, Treasury hired investment banking giant Morgan Stanley to help it "analyze and understand these authorities, should circumstances ever warrant their use." Morgan Stanley bankers are working with Treasury staff to come up with a series of options it could use to shore up Fannie and Freddie depending on various market conditions.

"Among the issues being debated is whether to force out management as part of any investment or loan. There is also debate about what to do about the companies in the long term. If Treasury were to take an equity stake at a high price, it would benefit shareholders. Coming in at a low price would essentially wipe out the shareholders, making the government the de facto owner of the firms. It's not clear whether Treasury would treat both companies equally or devise a rescue for one and not the other.

"Some market observers say an investment or a loan from the government will perpetuate a model that no longer works. Fannie and Freddie are government-sponsored enterprises -- meaning they were chartered by Congress -- and yet also public companies. "The better step would have been to have legislation that would have permitted them to be taken over immediately," said Peter Wallison, a former Treasury general counsel and critic of the companies.

"As home prices continue to fall in much of the country, the collateral backing loans guaranteed by Fannie and Freddie is dwindling in value. Zillow.com, a provider of real-estate data, released an estimate Tuesday that 14% of U.S. homeowners -- about one in seven -- owe more in mortgage debt than the current market value of their home.

"One option for both companies is to reduce their purchases of home loans and related securities to conserve capital. But that would reduce the flow of money into the market and push interest rates up for consumers, perhaps prolonging and deepening the housing slump."

* Sovereign Wealth Funds have been the suckers ... I mean, the investors ... that have provided huge amounts of capital to leading U.S. financial firms over the past year. Our banks and brokers have been passing the hat around in China, in Singapore, and all over Asia, as well as the Middle East.

The idea the early investors had: "This is a great time to buy blue chip financial firms on the cheap. Our money will help them absorb write downs and charge-offs. And then it will be off to the races again for the stocks." Unfortunately, every "kitchen sink" quarter of losses and every capital raise has been followed by even more kitchen sink quarters and even more capital raisings. So the early investors have lost their shirts.

Now, it appears that they may be getting cold feet. From the New York Post this morning on Lehman Brothers:

"Lehman Brothers' embattled Chief Executive Dick Fuld nearly struck a deal to raise almost $5 billion from South Korean wealth funds and institutions but the pact disintegrated, according to sources familiar with the matter.

"It's unclear why the deal fell apart earlier this month, although one source speculated that Lehman was aiming to raise more capital than the Korean investor was willing shell out at the time.

"The precise terms of the deal could not be learned.

"Fuld and his newly appointed lieutenant, COO and President Bart McDade, have been in numerous discussions with prospective investors about raising additional capital internationally.

Lehman needs the extra cash as protection against expected losses as it looks to unload tens of billions of dollars in commercial mortgage securities and other real-estate assets.

"A JPMorgan Chase analyst wrote on Monday that Lehman may writedown about $4 billion when it reports fiscal third-quarter earnings next month."

The Lehman CEO has been working to forge a deal with Korean entities since earlier in June, when he sought to raise an estimated $6 billion.

"However, those negotiations never culminated in a deal, sources said."