Are the low US home mortgage rates for real?

Oct 11, 2011 17:33 UTC

We hear on almost a weekly basis that mortgage interest rates in the US are at all-time lows. The annual percentage rates in mortgage advertisements seem near an historic nadir. The Fed has even begun to purchase long-dated mortgage backed securities (MBS) in an effort to push rates even lower and, hopefully, spur more refinancing activity.

But are these rates real? Are all American consumers, especially low-income borrowers, able to borrow at those low teaser rates? The answer in both cases is no. This is a crucial question, as we have discussed on this blog before. Home mortgage refinancing is the primary conduit for the Fed to provide liquidity to the US economy. In August of last year, I noted:

‘In every Fed easing event during my career in finance (1986, 1992, 1998, 2002), it was the wave of refinancing of debt after the Fed eased interest rates that put permanent disposable income into the hands of households,’ notes a former Fed official who worked in the banking industry for decades. ‘In this last easing, however, FNM, FRE and the TBTF banks have conspired to break the transmission mechanism for monetary policy and are now strangling the U.S. economy to save themselves from past errors.’

Since last year, little has changed. On Friday, Housing Wire reported that “Prepayments, mostly through refinancing, on mortgages backing Fannie Mae and Freddie Mac securities increased substantially in September, higher than what some analysts expected.” In fact, prepayment on FNM 4s surged over 100%, but the real story was the fact that prepayments on higher coupon FNM paper actually fell as shown in the table below.

Fannie Mae 30-Year Prepayments (September):

Coupon (vintage) Change in prepayment rate (%) Amount outstanding (B$)
4s (2009) + 130 102
4s (2010) +157 112
4.5 (2009) + 80 227
4.5 (2010) + 100 124
5 (2009) + 29 69
5 (2005) + 5 51
5.5 (2008) - 8 65
5.5 (2005) 0 45
6 (2007) - 4 62
6 (2006) - 8 43
6.5 (2007) - 13 16
6.5 (2006) - 9 17

Source: Fannie Mae/Absalon

While most of the business currently being written by banks and the GSEs is related to refinancing, the vast bulk of the loans are being written against relatively low coupon loans. Home owners with older, high coupon loans are largely excluded from the refinancing activity.

More, two of every three mortgage refinancings done by banks and guaranteed by the GSEs since 2008 have gone to higher income households. Low income families who need the benefit of lower rates are mostly locked out. One key telltale in the Fannie data about the discrimination against low income borrowers: The average loan size of the older, high-coupon loans is almost half that of new loans.

Notice that virtually all of the increases in prepayments were recorded in FNM 4s and 5s, while prepayment speeds actually fell for the older, higher coupon loans. The higher income households who held high coupon loans from the 2008 and earlier time frames have largely refinanced, leaving only the low income borrowers trapped by the GSEs and investors in MBS who do not want these needy American families to refinance.

Remember that the Fed is already diverting more than half a trillion dollars a year from savers to the banks through low interest rates. The behavior of the GSEs and the top four banks – JP Morgan, Bank of America, Citigroup and Wells Fargo – which prevent lower income Americans with performing loans to exercise their contractual right to refinance borders on the criminal. But in terms of public policy, the blockade by the GSEs and the zombie banks is blocking the Fed’s efforts to reflate the consumer sector and help the US economy.

Treasury Secretary Tim Geithner has stated that the Obama administration is moving forward with plans to help more homeowners refinance out of higher rates. But Congress and members of the media should ask Secretary Geithner why he has been dragging his feet with respect to forcing the GSEs to refinance all of these older, high coupon loans to help the most needy Americans. The fact that Geithner and Federal Housing Finance Administration chief Ed Demarco are responsible for blocking more than 30 million American families from refinancing their mortgages is an outrage.

What should be done? In a presentation to the Mortgage Bankers Association in Chicago the other day, Alan Boyce of the Absalon Project listed a number of steps that Geithner and the White House need to embrace. Obama should require FHFA to direct GSEs to use all tools available to stimulate more home refinancings. Specifically:

•Eliminate loan level pricing adjustments for the refinancing of ALL loans currently guaranteed by the GSEs

•Eliminate the 25bp “Adverse Market Fee” imposed after the government takeover of Fannie and Freddie.

•Eliminate appraisals and paperwork as part of a new “Super-Streamlined” refinance program

The key requirement is that the borrower be current on the existing mortgage that is guaranteed by the taxpayers. Boyce believes that following this approach will have big benefits. Some 25 million new refinancings from 32 million tax payer backed loans will reduce mortgage payments of about $51 billion. Lower income borrowers will get over half of these savings.

And there are big benefits for the banks. Underwater borrowers at greatest risk of default will get some financial breathing room. Improved labor mobility provided by refinancing will reduce unemployment and also help to lessen the chance of a second wave of loan defaults. And, most importantly, the single biggest obstacle to the Fed’s efforts to add liquidity to the consumer sector will be removed. The hour is late, but prompt action now can make a big difference to the economy in 2012 and beyond. Does President Obama have the courage to act?


Please remember that an unknown percentage of the high coupon loans have seconds which will need to be resubordinated. What do your numbers look like when you screen out the loans with seconds (and thirds)?

Posted by VoxNihili | Report as abusive

Fair-value accounting, derivatives increase global debt deflation

Oct 7, 2011 20:52 UTC

One of the themes I developed in my 2010 book, “Inflated: How Money & Debt Built the American Dream,” is the idea that significant amounts of the reported GDP and employment of the post-WWII period and especially since the 1980s has been based upon debt and inflation. The debt-deflation crises today affecting both the US, EU and even China and other “emerging” nations seems to confirm this view.

Two of the key symptoms we should consider to support this thesis regarding the role of inflation and debt in the industrial economies are 1) the rise of fair-value accounting and 2) the increase of derivatives, especially derivatives that settle in cash and have no direct link to any cash markets.

In an important paper by Mingzhe Yuan and Huifeng Liu of Shandong University, “The Economic Consequences of Fair Value Accounting,” the authors note there are two fatal intrinsic flaws of fair-value accounting:

One flaw concerns its non-complete existence, that is, the required fair value may not exist under certain conditions. One direct consequence of the flaw is that a huge fair value trap may be created by fair-value accounting when the fair value does not exist. Another flaw of fair-value accounting is its self-expansion, that is, the fair-value accounting acts as a share price bubble maker based upon the normal net incomes from the operations of listed firms. The bubble may then expand much larger than the original incomes.

The implementation of fair-value accounting in the US not only allowed for the creation of bubbles in asset prices, but the changes made by the Financial Accounting Standards Board in 2009 has enabled banks to hide hundreds of billions of dollars of unrealized losses on their balance sheets.

Before Treasury Secretary Tim Geithner lectures our European allies about going “too slow” on debt restructuring, he should clean up his own house. We have discussed the failure of Geithner to deal with the situation at Bank of America.

At a meeting of Professional Risk Managers International Association in 2007, Sylvain Raynes of RR Consulting, who also teaches at Baruch College, put the role of fair-value accounting into stark perspective:

Valuation is not the most important problem in finance; valuation is not the most interesting problem in finance; valuation is the only problem for finance. Once you know value, everything happens. Cash moves for value. More price does not mean more value. If you do not recognize the difference, the fundamental difference between price and value, then you are doomed… The Chicago School of Economics has been telling us for a century that price and value are identical, ie, they are the same number. What this means is that there is no such thing as a good deal, there is not such a thing as a bad deal, there are only fair deals.

The role of new era concepts such as fair-value accounting in fueling the crisis is just part of the story. The other symptom of a lack of real economic growth in the G-20 nations is the rise of cash settlement OTC derivatives and complex structured securities. From leveraged ETFs to currency swaps, the global financial markets are polluted with all manner of speculative instruments with no basis in the real economy.

Forward, futures and options markets are traded on exchanges and in organized markets, and are tightly disciplined by a limited supply of underlying assets, the cash “basis” for the derivative, which is not a problem. But when you talk about credit default swaps, collateralized debt obligations and other instruments which settle in cash and where the underlying basis does not have to be delivered, these instruments seem to validate the debt-deflation thesis. Unable to create real assets from real economic activity to meet the demand from investors holding fiat paper currencies, the markets create liabilities without any corresponding assets. The disease of cash settlement derivatives and structured assets is destroying many cash markets and banking systems around the world.

The derivatives epidemic is already visible in the US and EU economies, and is also affecting emerging markets. In Hungary, for example, global investment banks first used FX derivatives to blow up the local currency mortgage and banking market, driving consumers into foreign currency-linked home loans. The major derivatives dealers then left local lenders to fail as the currency market exposure turned catastrophic. Local lenders, who wrote massive foreign-currency swaps to enable domestic real estate lending, were decimated when the Hungarian currency weakened.

“The EU central bank just published a 100 page report on FX swaps alone,” notes a consultant to the central bank. “Derivatives ballooned Hungary’s FX exposure and debt. We are now trying to find a way to rebuild the domestic loan market amidst the smoldering ruins of this fiasco.”

Note the similarity between the situation in Hungary and that of Spain, Greece, Portugal and Ireland. In each case, derivatives allowed these nations to greatly increase domestic debt far beyond levels that the cash markets can support. In many cases these domestic borrowings carry foreign exchange exposures created via derivatives that magnify solvency problems enormously.

The leaders of the G-20 nations need to ask questions about the role of fair-value accounting and cash-settlement derivatives in fueling the current debt crisis. Until we accept that many of the economic problems we face today stem from efforts to create the illusion of growth in financial markets, there is not likely to be much progress on fashioning a sustainable solution.


This is a really interesting and insightful article, thank you for posting it. I think the best thing for all of us to do is just make sure that we are doing all we can to manage our finances so we know what is going on! I have been using an investment analysis software called Statpro which has helped me in analysing my value-based estate, litigation support, and acquisition activities. Even more so the most helpful tool I have used is the Asset pricing
which have really come into use when trying to assess my mortgage.

Posted by Ksween | Report as abusive

Geithner and the delicacy of Euro-Dollar diplomacy

Sep 16, 2011 15:57 UTC

The departure of US Treasury Secretary Timothy Geithner to Europe to rescue our allies from themselves marks a change in the economic relations among the NATO countries that bears scrutiny. In the past, the loosely-connected federation we call the European Union has managed to muddle along. But now we see overt funding subsidies for the EU via the Fed and the active involvement of Geithner in what ought to be a purely domestic fiscal discussion.

I suppose that kudos are in order for Geithner and Fed Chairman Ben Bernanke for finally responding to the EU funding crisis. Bernanke has been sound asleep at the liquidity nipple, not realizing it seems that the Fed supervisory personnel were instructing US institutions to sever credit lines with their EU counterparts. Since most of these banks are now effectively nationalized, the behavior of US regulators in New York seems especially self-injurious. Now we have replaced private funding for EU banks with central bank swap lines. Hoo-rah. This is not so much a rescue as it is a temporary subsidy.

Geithner has his work cut out for him. Having worked in the Federal Reserve Bank of New York in the currency area during the Plaza Accord, this author has some ideas on the financial and psychological efficacy of central bank intervention. The key thing for any central bank trading desk is not to pretend that you are the market, but instead to support market activity and to slowly help restore the flow of private credit in the markets. Unfortunately this lesson still seems lost on central bankers on both sides of the Atlantic.

My friend Achim Dübel of Finpolconsult in Berlin, is critical of the handling of the intervention by the European Central Bank. Referring to a recent research note by Goldman Sachs on the outlook for the EU, he asks:

Does GS have on its radar how distortive and damaging are the ECB interventions into periphery debt at 80 or 90 cents? The ECB bought Greek debt at those levels a year ago – average portfolio cost is estimated at 70-80 cents, where market prices are now 30 cents. Why are market prices now at 30 cents? Because the ECB had to stop buying. After looking into the abyss of Greek default, the ECB simply ran away.

In the case of Greece and now Italy, Dübel notes very aptly, the ECB has been buying bonds well above the true market. “Now they are doing the same with Italian debt as they did with Greece, and of course the ECB will run away again,” Dübel adds. “With the banks the intervention levels were far too high (haircuts too low), with the worst example of all being Ireland. In all these cases, ECB became an obstructionist force against restructuring, i.e. solving the problem.”

Now, it seems, we know why Axel Weber, the ECB’s German board member, resigned from the board in protest last year. Geithner needs to quickly figure out whether the core EU nations can begin to act in a more rational and purposeful way when attacking issues of solvency, both of banks and nations.

Lagarde recently warned that the egos of world leaders are putting the global economy at risk. This is a nice way of saying that none of the leaders of the G-20, elected or not, are in the mood to take the risk themselves of publicly confessing to the true scale of the problem of excess debt and shrinking demand facing each nation. But as Geithner goes to the EU to preach tough love to his European counterparts, he leaves a lot of unfinished business at home.

Geithner ignored President Barack Obama’s order to consider dissolving Citigroup, a new book by Pulitzer Prize-winning author Ron Suskind claims. The top four banks in the US remain on the critical list, even with bulging deposits and capital levels. So when Geithner lectures his EU peers on the need for prompt and purposeful action, he will need to season his advice with humility and an appreciation that the war against global deflation is far from won.


Astuga, I beg to differ. The way the EU has behaved over the last 2 years as each crisis comes and goes shows that member states are a very loose federation indeed. Given that they cannot agree amongst themselves or with the ECB or with Geithner shows that too.

Given the lack of any suitable solution on the table at the EU ministers meeting last week, Geithner merely put forward an idea that might cover middle ground. It seems that Geithner realises the gravity of the situation unlike our fellow Europeans. It does look like the EU is not going to listen to the markets (quote from Manual Barroso) until it is too late.

Merkel and Sarkozy pushed Europe into the Euro and now they have it they do not know what to do. They are responsible for 500m people in Europe and they all deserve better leadership than all of the EU bureaucrats have shown so far. Whilst the US has trouble too, at least they have a plan which is one thing that we sadly do not have.

Posted by SCSCSCSC | Report as abusive