Interest Rate Roundup

Wednesday, June 20, 2007

Dispatches from the housing and mortgage front

Good Wednesday morning -- If you have some time for "light" reading, you're in for a treat. There's a lot of news on the housing and mortgage front this fine a.m.

First off, check out this big story from Bloomberg. It tackles the issue of whether the housing sector is done going down, what the impact from higher mortgage rates will be, and how much -- if at all -- the housing slowdown will hit the broader economy. Some key points and facts from the piece (many of which I've touched upon before in this blog, but are worth recapping since Bloomberg has done a good job of bringing them all together in one place):

- National median prices will likely decline this year for the first time since the Great Depression (on an annual basis, that is).

- New home sales will likely drop 33% from the 2005 high to the end of 2007, making this downturn worse than the drop in 1991 (25% over three years), per the National Association of Realtors.

- Adjustable rate loans captured 29% of the market, on average, over the past three years. That compared with 17% over the previous three years. Now, those borrowers are facing rate and payment resets that will stretch their budgets.

- Mortgage rates have risen more quickly in recent weeks than at any time since 2004. That means borrowers can afford 8% less house.

- A greater percentage of home mortgages (0.58%) entered foreclosure in Q1 2007 than at any other time in history.

Second, it looks like the days might be numbered for a pair of Bear Stearns mortgage hedge funds, according to the Wall Street Journal (subscription required). These funds made big bets with borrowed money on subprime mortgage bonds. Turns out (surprise, surprise) that wasn't exactly the best path to investment riches. Here's an excerpt ...

"Two big hedge funds at Bear Stearns Cos. were close to being shut down last night as a rescue plan developed over several days fell apart in a drama that could have wide-ranging consequences for Wall Street and investors.

"Merrill Lynch & Co., one of the hedge funds' lenders, said it would move to seize collateral -- much of it mortgage-backed debt -- from the two funds and sell it, according to documents reviewed by The Wall Street Journal. At the same time, the funds' managers worked with a handful of other key lenders, including Goldman Sachs Group Inc. and Bank of America Corp., to pay off the funds' $9 billion in loans, according to a person familiar with the matter.

"As of a few weeks ago, the two Bear Stearns hedge funds held more than $20 billion of investments, mostly in complex securities made up of bonds backed by subprime mortgages -- the relatively risky home loans made to borrowers with troubled credit histories.

"In recent weeks, however, the firm's High Grade Structured Credit Strategies Enhanced Leverage Fund and High Grade Structured Credit Strategies Fund have been besieged by investors and lenders trying to recover their money as the value of the funds' underlying bonds fell sharply."

Unlike the Long-Term Capital Management meltdown in 1998, which had a significant impact on the broader capital markets, this Bear Stearns implosion hasn't derailed things.

But here's the thing -- a lot of investors are carrying subprime mortgage bonds, so-called collateralized debt obligations (CDOs), and other instruments that are valued based on certain pricing assumptions. If these Bear Stearns funds have a fire sale, and the MARKET sets new prices for its investments, other firms may need to revalue their holdings based on those market prices. That could lead to some nasty write-downs. Here's how the WSJ explained it:

"On Wall Street, the Bear Stearns hedge funds' problems point to another sensitive issue: Markets for exotic investments like derivatives linked to subprime mortgages have exploded in size in the past few years, but it is often hard to attach an accurate value to those assets.

"Last month, Enhanced Leverage reported that its value fell 6.75% in April after the fund's bets on the mortgage market went wrong. Two weeks later, it put the loss at 18%, spooking already-nervous investors and creditors and sending many of them running for the exits.

"The huge revision at least in part reflected conversations Bear Stearns hedge-fund managers had with bond dealers, three of which told them in late April that some of the funds' assets were worth less than the values stated on the funds' books, according to a person familiar with the matter.

"So far the turmoil doesn't seem to be significantly hurting the broader bond markets. But as the Bear Stearns funds unwind positions, investors and traders could reassess the value of other debt securities. As a result, investors far beyond the reach of the funds could find their holdings of similar debt worth less than they thought."

Third, the Mortgage Bankers Association's purchase mortgage applications index pulled back in the most recent week - by almost 3% to 450.9. It's still up quite a bit from its early 2007 low, but some of the gains likely stem from borrowers trying to "beat the clock" on interest rates. In a nutshell, they see rates are surging, so they clamor to get their applications in to their lenders before rates climb even higher.

Can purchases maintain their momentum now that rates are a lot higher? Or is the dip in the most recent week a sign of things to come? I tend to think the second of those two scenarios will play out. But only time will tell.


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