All Things in Moderation

Vital Statistics:

Markets are weaker this morning in spite of better than expected initial jobless claims and couple of new mergers (Berkshire Hathaway buying Heinz, and US Airways / American Airlines). The Eurozone economy weakened. Bonds and MBS are flat.

In the State of the Union, President Obama referred to “overlapping regulations” and called for streamlining the mortgage process.  The housing industry is hoping that means that the Qualified Residential Mortgage rule (promulgated by the banking regulators) and the Qualified Mortgage Rule (promulgated by CFPB) will become consistent with each other.  The sticking point is that the QRM rule is much more strict than the QM rule (QRM: 20% down, 36% DTI), vs QM (43% DTI). Bankers and consumer groups hope to have the down payment rule removed, and would ultimately like to see the QRM rule to match the QM rule.  It seems that there is some bipartisan consensus on this.

Speaking of the SOTU, Obama’s agenda drew little support from Republicans, who “called it dead in the water.”  John Boehner objected that his plan raises the price of employment and noted that when you increase the cost of something, you get less of it.  Mitch McConnell referred to it as “liberal boilerplate that any Democratic lawmaker could have given at any time in recent memory.”  John Thune noted that Obama would have a hard time getting Democrats to go along with portions of it.  Six Senate Democrats seeking re-election next year in states that supported Mitt Romney are going to be hard pressed to vote fore new tax revenues beyond what has already been approved.  At the end of the day, it will depend on whether Obama chooses to demagogue or deal. On the minimum wage, one Republican said it would have a chance if it was accompanied by a business package of tax credits and expensing rules to help small business.  Paul Ryan noted that Obama chose not to politicize immigration reform, which means that something can be done there.

Sen Tom Coburn, R-OK says the sequestration cuts are going to happen. I still think it is much ado about nothing.  Some facts:

Spending Side:

• Total Sequestration cuts:  $85 billion
• Requested increase in the budget from FY12 – FY13: $75 billion
• Net change in spending: ~ $10B (or about 6 basis points of GDP)

St Louis Fed Head James Bullard gave an upbeat presentation at Arkansas State University, noting that the Euro sovereign debt crisis seems to have calmed down and that some of the uncertainty in the US economy has been dissipating. The most important news came with the Q&A with reporters – he is not ready to call for an end to QE, and would defer any decision-making until this summer to see if the economy continues to improve. 

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Markets are up slightly after retail sales came in as expected. Ex auto and gas, they disappointed. However, there was some fear that the Jan 1 tax hikes would curtail consumer spending.  At least this data point shows it hasn’t.  Although to be fair, a +.1% increase is nothing to write home about. Mortgage applications fell. 

CoreLogic’s latest Market Pulse previews 2013. They predict that the refi boom is over, but it will be some time before the purchase market comes back. They note that 2012 census data indicates that household formations increased by 1 million, which is getting back to normalcy.  As I have said before, there is a lot of pent-up demand here, as the low household formation numbers of the last 5 years have been driven by economic weakness, not demographics. They do forecast that margins may get compressed as lenders fight over a declining amount of activity. That said, you can’t turn a refi shop into a purchase shop overnight. They also do an interesting analysis of the expected effect of QM loans. Near term, it will probably increase the profile of the GSEs.  Longer term, it will greatly increase performance characteristics.  Anyway, lots of good stuff in here.  RTWT.

27% of borrowers who refi are shortening their terms, according to Freddie Mac.  Cash-out refis account for just 16% of refinances, while cash in refis have jumped to 39%.  Ironic that consumers are getting more conservative when the Fed is using every tool in its toolbox to get consumers to do the exact opposite. 

Looks like the sequestration cuts are going to happen.

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Markets are flattish as the G-7 countries promise not to target currency rates with economic policies. Barclay’s is cutting 3,700 jobs. The President gives his state of the union address tonight, and it will focus on the economy and job creation.  Bonds and MBS are flat.

The National Association of Realtors reported that the median price of an existing home rose 10% in Q411 to 178,900 from 162,600 in Q411. That puts the median house price to median income ratio roughly at 3.53x, which is towards the top of its historic 3.15 – 3.55x range. This begs the question:  Is housing overvalued?  Perhaps, but wages have gone nowhere for 6 years.  Perhaps this time, wages catch up.

Chart:  Median House Price to Median Income Ratio:

The National Federation of Independent Businesses released its Small Business Optimism survey, and while it increased, it was still a dismal reading. On the plus side, more small business owners are hiring than firing. Capital Expenditures are increasing, although they are still in maintenance mode. Overall, the report suggests that sentiment is improving, albeit from very low levels.

McGraw Hill (owner of Standard and Poors) comes out swinging against the DOJ in their latest earnings release. They point out that the US cherry-picked a few emails, and that alone is only evidence of an atmosphere of “vigorous debate” but not wrongdoing.  They note that they were downgrading CDOs with 2006 vintage RMBS a year and a half before Lehman failed (which actually co-incides with the beginning of the financial crisis, IMO).  I remember the credit markets beginning to freeze in the summer of 2007, which was being called a “buyers strike.”  Finally, they note that virtually everyone missed the housing bubble, and the fact that their actions proved to be insufficient in hindsight does not prove intentional misconduct at S&P.

The state of Nevada is taking steps to reduce shadow inventory by buying distressed pools of mortgages and working them out to reduce principal.  They will purchase homes at 70% of appraised value and re-work the loan or foreclose and re-sell the property.  It will be administered by a non-profit entity. It will be funded with receipts from the National Mortgage Settlement. Once the loan has been seasoned as a re-performer, it will be sold back into the market and the money recycled. 

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Markets are flattish on no real news. Most of Asia was closed overnight for the lunar new year.  The G7 is expected to make a statement against competitive devaluation.  There is no economic data this morning, but many will be looking at tomorrow’s retail sales report to get a gauge on how much consumers have been affected by the increase in taxes.  Bonds and MBS are flat.

The internal debate at the Fed concerns how to start extricating itself from the market. As QE winds down, the Fed wants to prevent the market from getting ahead of it and prematurely slowing down the economy. The fear is that the market will interpret the end of QE as a signal that the end of ZIRP is imminent. Since the Fed has given numerical targets for the end of ZIRP, this fear is probably overblown, but targets can be changed. That said, if you look at the float numbers, the Fed has effectively cornered the market in 10 to 20 year bonds. And they have the buying power to maintain it.  The exit may involve simply holding the paper and letting it mature.

HUD just made it easier to prove discrimination cases.  Under the disparate impact rule, statistical proof that your lending mix is different that the population as a whole means you are guilty of discrimination, no matter what your policy or intention is.  Period. Obviously this is a huge victory for affordable housing advocates. The Mortgage Bankers Association is unhappy. IMO, this whole debate of FICO explaining everything misses the point that collateral valuation volatility in some neighborhoods is higher than in others.  Since the borrower is effectively long a put (if the house drops below the loan amount, they can toss the keys to the bank), and the value of a put is a function of volatility, then that has to be priced in the loan. And if house prices are more volatile in Detroit, or Harrisburg, or Newark then loans there should cost more to reflect that.  Which means FICO is not the whole story, contrary to what housing advocates insist.

45 Democrats sent a letter calling on President Obama to permanently replace Acting FHFA Director Ed DeMarco with someone more “willing to implement all of Congress’ directives to meet the critical challenges still facing our nation’s housing finance markets.”  This statement means willing to forgive principal on Freddie and Fannie loans. The mandate to put taxpayers first is at loggerheads with the desire to ease the financial burden on consumers. 

Separately, the White House is considering more mortgage relief for homeowners through executive order. The plan would allow underwater homeowners who are current on their mortgage to refinance at today’s rates, even if their loans are private label.   

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Another slow news day.  Markets are flat after the ECB maintained interest rates.  Initial Jobless Claims rose to 366k last week, while productivity fell.  Bonds and MBS are down small.

Jimmy Rogers is getting short Treasuries. He has been saying bonds have been in a bubble since 2009, though he has only started shorting them recently.  He plans to increase his position. Guys like Jimmy Rogers can’t affect bond prices (they are too small), but the Fed can, and will once it ends QE and begins to unwind its balance sheet.  The bond vigilante has been dormant for 20 years, but is about to make a re-appearance.

The National Association of Homebuilders Improving Markets Index expanded to 259 in February, with all 50 states represented. Roughly 70% of the metros covered were listed as improving. 

Even though the financial crisis ended long ago, the scars still linger.

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Slow news day. Stock index futures are lower after yesterday’s strong rally.  MBA mortgage applications rose 3.4% in the week ended Feb 1. The ECB meets later today.  Bonds and MBS are up.

Earnings season is starting to wind down.  Roughly 3/4 of all the companies in the S&P 500 have released earnings so far.  2/3 have beaten forecasts.

Pension funds and endowments are getting out of the commodities markets after returns have disappointed. When commodities started rallying about 6-7 years ago, big pension funds began buying commodities as a way to increase exposure to assets uncorrelated with stocks and bonds.  The problem is that these markets are relatively tiny compared to stocks and bonds (the dollar value of the entire open interest in the March WTI crude oil contract is about the same dollar value of Exxon Mobil stock traded daily). This meant that pension funds were driving up prices of commodities as they bought them.  And it wasn’t just oil – it was copper, lumber, wheat as well.  Unlike traditional speculators who buy and sell, the big institutions were making a long-term investment, which is more or less unheard-of in the commodities market, at least on a large scale.  Large OTC derivatives contracts allowed them to get around position limits, and those will be restricted in Dodd Frank. The punch line is that their exit will put pressure on commodity prices and keep inflation in check. It will also be a good thing for cash-strapped consumers. Where is the money going?  TIPS.

The Justice Department is suing S&P over ratings for subprime mortgages.  The complaint is here. The government is going to focus on conflict-of-interest issues (the issuer pays the ratings agency, not the investor) and supposedly not go after them for failing to predict the bursting of the housing bubble. Some of the damning emails are here. Sure, maybe ratings agencies may have suspected the housing bubble was bursting.  Does that mean that professional investors who relied solely on S&P’s rating get a pass?  A professional investor’s claim that “I bought this security because S&P said it was okay” ranks up there with “The dog ate my homework.” They do have a fiduciary duty, after all…

GOP Senators Bob Corker and David Vitter have introduced a bill to remove the dual mandate and direct the Fed to focus on inflation only.  Needless to say the bill is going nowhere in the Democratically-controlled Senate, but is should hopefully spark some debate.  Does the dual mandate compel the Fed to keep interest rates too low and does that fuel speculative bubbles?  

Separately, Senate Republicans have sent the President a letter suggesting that there be a bipartisan board of directors to oversee the CFPB and that its budget be subject to the annual appropriation process.  Actually, the 5 member board was part of the original proposal.  Again, this will probably end up going nowhere.

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Markets have a better tone this morning after yesterday’s sell-off.  Euro sovereign yields are down.  Bond yields are at the 2% level.

Stock index futures back up.  Dell doing a $23B LBO. Retail Investors Returning. Bonds can’t get out of their own way. Is the risk-on trade happening?  Feels like it. That said, the S&P 500 is nearing the top of its trading range since 2000. The 1970s bear market was a rangebound market where people would start to pile in at the top, only to have a crisis or inflation push the market back down.  The final cri de coeur was Business Week’s late 1979 piece The Death of Equities. That is what secular bear markets feel like when they end. The article even quotes a very happy diamond dealer in NY after ERISA changed the laws to let institutions buy hard assets, as if CALPERS was going to start burying gemstones in the back yard. 

Chart:  1970s Bear Market in Stocks.

The CoreLogic Home Price Index rose 8.3% in December, the biggest jump since May 2006. Excluding distressed sales, prices increased 7.5%.  They are forecasting a 7.9% YOY jump in January. The states with the biggest growth were AZ, NV, ID, CA, and HI.  The worst were DE, IL, NJ, and PA. It does feel like the secular bear in real estate is over. 

Listings of new homes has dropped to a 12-year low. For all of the fears of the shadow inventory, the problem seems to be a lack of merchandise. Many potential sellers are holding out for better prices, while professional investors are buying properties before they even hit the market.  Mark Zandi of Moody’s estimates that inventories might remain tight for a year or two. Sellers are worried that they may not be able to find a replacement home if they sell. This means the homebuilders are going to have a very good year.

Senate Democrats are trying to figure out a way to delay the sequestration cuts scheduled to take effect March 1. They are looking to replace the spending cuts with a surtax on oil companies and an end to the carried interest loophole. Meanwhile, House Republicans are considering a stopgap measure that would fund the government through Sep 30, which is $974 billion, well below the current level of $1.043T. Implicit in that measure is the assumption that the sequestration cuts happen. Republicans are resigned to having to accept the sequestration cuts and don’t have the appetite to try an negotiate a deal with the WH, which is going to delay releasing its budget until late March. While it has zero prospect of getting enacted as-is, it will be a clue as to whether the President is interested in some sort of long-term solution to the budget or is content to fiddle at the margins with what is currently out there.

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Markets are weaker on the back of big declines in the Italian and Spanish bourses. Euro sovereign yields are starting to tick back up. There doesn’t seem to be a story out there driving it. 

As the bond market has backed up, there is a lot of talk about whether this is the big rotation out of bonds and into stocks. Within the bond market, there is a rotation out of Treasuries and into high yield. Overall, the “risk on” trade seems to be gaining steam, which means we have seen the low point for mortgage rates. It also means that the private label market might come back.

Obama wants more revenue, specifically through reducing loopholes and deductions. I don’t know if this is posturing for the sequestration cuts or something else. Liberals are using the negative Q4 GDP report to argue that we can’t cut spending. That is simplistic – Q3 government spending was higher than normal due to the government’s “use it or lose it” budgeting. The government’s fiscal year ends in September, and there is always a push to spend your budget, even if you don’t really need it, to ensure your budget doesn’t get cut. Which means that Q4’s government spending was borrowed in Q3. Obama is being a little disingenuous when he says things like “The big problem was defense spending was cut 22 percent, the biggest drop in 40 years.” which implies we are already cutting to the bone. He is in favor of “smart spending reductions,” whatever that means, to bring down the deficit.  I suspect the only smart spending reductions he favors are the Orwellian-named “tax expenditures” and oil subsidies.  And don’t forget, the definition of what is considered a spending cut depends greatly on what the baseline is when you start counting. Many in Washington prefer to use the baseline from when spending was the highest (late 2010) as the baseline, project spending out 10 years from there, and count any difference between the old projection and the new projection as a “spending cut.”

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