10-Year Swap Spreads - Go negative!

A benchmark for the US mortgage market has gone AWOL! The difference between the 10-year LIBOR and 10-year US Treasury yields is NEGATIVE. The enormous issuance of debt and persistent agenda of using it to revive the dead patient is about to bite back. The 10-year yield will go higher.

As I've forecasted long ago, I do not expect mortgage rates to follow. Not for long. The disinflation is transforming into the ugly deflation threat now and that will kill any inflationary attempt. That means the real estate market gets hit at both ends of the affordability curve. And that is a correct response due to supply being held back from sale by banks as well as owners. The shadow inventory is estimated at THREE TIMES the listed number for the past two years now.

Spring will be but a blip, and quickly a bust! So all you fair weather fans who are just itching to get into your own home (aka INVESTMENT), start talking to your strategic default adviser before you sign at closing.

In Hoboken, fair value will now be deemed at a comp equivalent to mid-2003, down from early 2004 just a few months ago. The so-called recovery in prices has been a talking point aimed at marketing traffic. I wonder how many real estate professionals are being taken to court these days? Well, watch for that phenomenon soon. Far too many with advice rather than information and clarity on a property's financial history.

This bounce will try for one last gasp as spring approaches... and fail miserably. Peak to trough prices will start approaching the magic 40% mark for the metro NYC area. Is it any wonder that we have one-family homes racing to market right now?

Price it right! Or look for a lifesaver later.

Geithner's Testimony Leaked Night Before

The Treasury Secretary is making it clear to all those holding real estate assets: conditions have not improved to warrant stabilization in the residential market. In (mistakenly leaked) written testimony for the House Committee on Financial Services tomorrow morning, Geithner opens with the following:

"Private capital has not yet returned to provide the amount of funding that would be needed to allow families to get a mortgage to buy a new home or to sensibly refinance the house they already live in. Without the continued activity of the GSEs and the Federal Housing Administration (FHA) in the current environment, mortgage rates
would be higher and homeowners would have a significantly harder time obtaining credit. While conservatorship, undertaken by the Federal Housing Finance Agency (FHFA) during the Bush Administration, pursuant to Congressional authorization under the Housing and Economic Recovery Act (HERA), and continued under the Obama Administration, was necessary, together we must begin the process of fundamental reassessment and reform.

The failure of Fannie Mae and Freddie Mac was part of a broader crisis that revealed structural flaws in the entire housing finance system. Housing markets are subject to booms and busts – a key issue is whether the system of housing finance acts to dampen such cycles or to worsen them.
In this case the verdict is woefully clear. For many years, the housing finance system provided credit to households in a reliable and stable manner, setting appropriate standards for mortgage origination, and attracting diverse sources of capital though securitization. However, insufficient regulation and enforcement was unable to check increasingly lax underwriting, irresponsible lending and excessive risk taking. Increasing usage of complex products led to a growing misalignment of incentives facing mortgage brokers, originators, credit investors and borrowers.
This fueled unsustainable debt levels and house price appreciation. The risk of a fall in home prices was ignored by most and there was too much leverage in every part of the system. These problems were worst in the least regulated non-bank sectors that fed private-label securitizations.
Over time, problems associated with the absence of prudent underwriting standards and effective consumer protection migrated from these sectors to the more highly regulated channels of mortgage origination, including the banking sector."

If you haven't understood our discussions here surrounding deleveraging, Mr. Geithner is reading the definition to all who want to hear the truth. In due course, expect changes to the financing markets that parallel the real estate markets as well. You are being forewarned.

Don't Confuse Larger Picture With Noise!

The attached chart shows the state of the MBA Purchase Index.

The issue to consider is what lower rates HAVEN'T BEEN ABLE TO DO to this trend. The 4-week average takes us back to 1997 levels so far!

Affordability my ass!

The Kitchen Sink - Literally!

By JAMES R. HAGERTY

Pressure is growing on U.S. banks to ease terms for distressed homeowners on home-equity loans and other second-lien mortgages.

Rep. Barney Frank, chairman of the House Financial Services Committee, last week sent a letter to the four biggest U.S. banks demanding "immediate steps to write down second mortgages." The Massachusetts Democrat sent the letter to the chief executive officers of Bank of America Corp., Citigroup Inc., J.P. Morgan Chase & Co. and Wells Fargo & Co. Meanwhile, the Obama administration is preparing to launch long-planned initiatives aimed at addressing these obstacles.

Frank's Letter

Read Rep. Frank's letter to the four biggest U.S. banks

Rep. Frank said banks' reluctance to write down second mortgages is blocking efforts to reduce the first-lien mortgage balances of many borrowers who owe far more on their loans than the current values of their homes. Because such "underwater" borrowers often feel little incentive to keep paying, "homeowners are increasingly deciding to walk away and thus foreclosures continue to mount," he said.

View Full Image

Bloomberg News

A for-sale sign in front of a Newport Beach, Calif. home in December.

Many second liens have little value because of the plunge in home prices, Rep. Frank wrote, adding: "Yet because accounting rules allow holders of these seconds to carry the loans at artificially high values, many refuse to acknowledge the losses and write down the loans."

A Bank of America spokesman said that bank is "committed to working with all interested parties to develop additional solutions to help homeowners modify first and second mortgages." A J.P. Morgan spokesman declined to comment. Representatives of Citigroup and Wells provided no immediate comment.

Lack of cooperation from holders of second liens also can block short sales, in which the first-lien lender agrees to allow the home to be sold for less than the loan balance due to avoid a foreclosure. If the second-lien holder continues to press its claim against the borrower, the sale can fall through. The ensuing foreclosure is likely to be more costly for all the parties than a short sale would have been.

Under an Obama administration program due to begin in the next few weeks, borrowers who get reduced payments on their first-lien mortgage through the administration's Home Affordable Modification Program automatically would get a break on their second-lien mortgage. Bank of America Corp. already has agreed to take part in this program, and other big lenders are expected to follow suit.

In April, the administration is due to launch financial incentives to encourage alternatives to foreclosure for people who don't qualify for a loan modification. The alternatives include short sales and so-called deeds in lieu of foreclosure, in which the borrower voluntarily gives up title to the home and often gets cash to help with moving expenses.

Under this Home Affordable Foreclosure Alternatives program, holders of second-lien mortgages would be eligible to be paid 3% of the unpaid loan balance, up to a maximum of $3,000, for giving up all claims in the event of a short sale. Unclear is how many second-lien holders would participate.

Most first-lien home loans are held by the government-controlled mortgage companies Fannie Mae and Freddie Mac or by other investors in mortgage securities. By contrast, banks hold most of the seconds and other junior-lien mortgages. About $1.05 trillion of junior-lien home mortgages were outstanding as of Sept. 30, according to the Federal Reserve. Of those, $766.7 billion were held by commercial banks; most of the rest were owned by savings banks and credit unions.

If banks are forced to write down or write off large amounts of those second mortgages, many would suffer major dents in their capital. Laurie Goodman, a senior managing director at mortgage-bond trader Amherst Securities Group LP, said regulators may need to allow banks to recognize losses on second-lien loans over an extended period to avert a disastrous immediate hit to their capital.

One reason banks are reluctant to write off second mortgages is that some may still have value even after a foreclosure. Though the foreclosure wipes out the lien on the home, the consumer still has a legal obligation to repay the second mortgage debt in some cases. If the borrower has no significant assets remaining, banks generally don't bother trying to collect that debt. But they do retain that option and some say they will pursue it in cases where the borrower has significant assets or income, or may later have the ability to repay.

Write to James R. Hagerty at bob.hagerty@wsj.com

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