Wednesday, March 4, 2009

The mortgage market is sagging this morning, weighed down as trading activity in the stock markets show flickers of life and as investors brace for an announcement tomorrow of another massive round of Treasury borrowing.

The Treasury Department is expected to announce it plans to sell $33 billion of three-year notes on March 10th, $17 billion of 10-year notes on March 11th and $10 billion of 30-year bonds on March 12th - for an eye-popping total of $60 billion.

The "so what" factor here is that investors haven't yet fully digested the $94 billion they were served last week so appetites for this massive round of new supply may be fairly thin. If this assessment proves accurate, the government will likely find it necessary to "sweeten-the-pot" by offering higher returns on these securities which is a scenario that will almost certainly cause mortgage interest rates to edge higher as well.

The mortgage market is also struggling with President Obama's $275 billion Homeowner Affordability and Stability plan aimed at making refinancing easier for a select group of American homeowners. Here is a synopsis of the homeowner rescue concept:

The plan has three components. The first would help homeowners who are still current on their payments, but who are paying high interest rates and cannot refinance because they do not have enough equity in their homes, a problem afflicting growing numbers of people as housing values tumble.

A second component would assist about four million people who are at risk of losing their homes. It would provide incentives to lenders who alter the terms of loans to make them affordable for the troubled borrowers. (Editorial comment: Where else but in America can you borrow your down payment, take out a first and second lien and still be considered a homeowner.)

A third component would try to increase the credit available for mortgages in general by giving $200 billion of additional financial backing to Fannie Mae and Freddie Mac.

Beyond luring lenders with government money, the plan also calls on Congress to give bankruptcy judges the power to change the terms of mortgages and reduce the monthly payments.

The banking industry has vehemently fought that proposal for more than a year, saying it would make investors unwilling to finance future mortgage lending. But Democrats in Congress strongly support the idea and banking executives are putting up less resistance than before. In my judgment the law of unintended consequences is at play. As I mentioned before, if bankruptcy judges are given unilateral authority to modify an existing mortgage such an event immediately changes the risk profile of the underlying mortgage-backed security.

From a fixed-income investor's perspective -- risk begets rate -- which means future homebuyers will very likely wind-up paying higher interest rates so that a relative few can enjoy lower mortgage interest rates now. I don't know about you - but I personally question the wisdom of granting individuals who misrepresented their income and/or assets on their original mortgage application the benefit of taxpayer assistance now.

For those of you hoping to see refinance volume improve because of this homeowner rescue plan -- I fear you may be disappointed. The $75 billion that will be used to modify existing mortgages will flow through servicers - not originators. That's the bad news. The good news is the $200 billion that is scheduled to be given to Fannie Mae and Freddie Mac with likely find its way into the mortgage market - but at current rates - and through normal channels.

Speaking of production - the Mortgage Bankers of America reported this morning their seasonally adjusted mortgage application index, made up of both purchase and refinance loans, fell 12.6% last week. Refinance applications were down 15.3% for the period while the purchase index slumped 5.6%.