Interest Rate Roundup

Friday, January 25, 2008

Quick hits and bullets, plus some thoughts on the mortgage cap plan

I've been very busy today, so haven't had time to post. But I wanted to highlight and comment on a few news items ....

First, the firings are starting to happen on Wall Street. Credit Suisse, Lehman Brothers, and a few other firms are reportedly letting employees go in the commercial mortgage arnea. Goldman Sachs is also jettisoning up to 5% of its employees, or about 1,500 people, though the firm is characterizing it as normal pruning of underperformers.

Second (and speaking of commercial mortgages), spreads are blowing out in the Commercial Mortgage Backed Securities (CMBS) market. Bloomberg notes that investors are demanding 244 basis points of extra yield on AAA-rated, 10-year commercial mortgage paper. That's the highest spread in history (The data -- a Morgan Stanley index -- goes back to 1996).

Here's some more perspective on what's going on there:

"While the yield on 10-year Treasury notes fell 1.43 percentage points in the past three months to the lowest since 2003 following four interest rate cuts, the cost of borrowing for apartment buildings, offices, retail properties and hotels climbed as much as 1.25 percentage points, according to David McLain, principal and chief investment officer of Palisades Financial LLC, a private equity firm in Fort Lee, New Jersey.

"The market is locked up right now because there's a huge overhang of leveraged assets of every type, development deals that won't meet projections made last year when things were rosy,'' said David Tobin, a principal at New York-based Mission Capital Advisors LLC, which was involved in $5 billion of asset sales last year. "It will end just like the residential housing market.''
"Bernanke's easing hasn't stopped the $3.2 trillion commercial market from starting a slide that mirrors the housing decline, where prices have dropped for the first time since the Great Depression. U.S. commercial property prices probably will fall 10 percent in 2008 from last year's peak after rising 60 percent since 2002, said Dan Fasulo, director of market analysis at New York-based research firm Real Capital Analytics Inc."

Frankly, I think the prices of many commercial properties rose to unsustainable heights for the same reason the price of many residential properties did: Too much risky lending, fueled by too much easy money, invested by too many firms that were chasing yield any place they could get it. And thanks to the explosion in securitization, firms had little incentive to care about the ultimate performance of the loans they underwrote (sound familiar?). Again, from Bloomberg:

"Wall Street underwriters allowed lending guidelines to slacken because they needed the mortgages to feed the $760 billion market for securities backed by commercial mortgages, said Scott Tross, a mortgage specialist and partner at the Herrick, Feinstein LLP law firm in Newark, New Jersey.

"Lending standards became more lax because people knew they wouldn't be keeping the loans on their books,'' Tross said.

Third, this idea of allowing Fannie Mae and Freddie Mac to buy bigger mortgages (and allowing FHA to insure larger ones) seems misguided to me. The idea is to help lower rates on loans that would formerly fall into the "jumbo" category, and to allow FHA to penetrate a wider range of markets (it has been essentially "priced out" of many areas because of its loan caps).

It's clear that policymakers want to be seen as doing something about the housing crisis, especially in an election year. I get that. And naturally, the real estate lobby is pleased because this will likely juice housing demand a bit.

But the agency responsible for ensuring safety and soundness at Fannie and Freddie sure isn't thrilled. This recent note (PDF link) from OFHEO lays out several reasons why this idea isn't all it's cracked up to be.

There are also questions about whether this change may actually RAISE mortgage rates in the long run. And even if it doesn't, why exactly are we rushing to subsidize such large mortgages? Why does it make sense to put more risk on FHA's shoulders -- or Fannie Mae's and Freddie Mac's? Private lenders are getting killed for taking on too much mortgage risk ... and rightfully so. Why would we want to set the stage for a similar debacle down the road ... only this time, one that could require a taxpayer-funded bailout (Do you really think taxpayers won't be called on to help Fannie, Freddie or the FHA if a serious, future delinquency crisis struck?)

Most importantly ...

The reason so many people are defaulting in the first place is because the private mortgage industry did a whole host of imprudent things to get people into overvalued homes they really couldn't afford. That drove home prices to unsustainable levels. The solution isn't to try to find ways to artificially prop up prices. It's to let the market do its thing and bring prices down to a reasonable level. That way, borrowers can buy homes with traditional mortgages ... at reasonable debt-to-income ratios ... with tolerable monthly payments and actual ... wait for it ... down payments. What a concept!


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