Morning Report – Bill Gross’ investment outlook and why the CRA disparate impact analysis is all wet. 6/27/13

Vital Statistics:

  Last Change Percent
S&P Futures  1604.5 9.0 0.56%
Eurostoxx Index 2604.7 1.9 0.07%
Oil (WTI) 95.87 0.4 0.39%
LIBOR 0.274 -0.002 -0.58%
US Dollar Index (DXY) 82.85 -0.128 -0.15%
10 Year Govt Bond Yield 2.49% -0.05%  
Current Coupon Ginnie Mae TBA 101.7 0.3  
Current Coupon Fannie Mae TBA 101.1 0.4  
RPX Composite Real Estate Index 205.6 0.2  
BankRate 30 Year Fixed Rate Mortgage 4.57    


Markets are up this morning as personal income comes in a little better than expected, and personal spending comes in at expectations. Initial Jobless Claims came in at 346k, more or less in line with expectations. Bonds and MBS are up.
The Corker – Warner Bill to wind down the GSEs is out. The full text of the bill (all 154 pages of it) are here. Punch line: GSEs are wound down, their liabilities are transferred to the taxpayer, some private entity will bear the first 10% loss on new securitizations, and the Federal Mortgage Insurance Corporation (FMIC) will re-insure losses over 10%. 
Bill Gross’s latest investment outlook takes the view that the recent spike in rates was overdone.Yes, there was too much risk in the system (read leverage) and the Fed needed to act to squeeze some of that out. But, he believes that the 10 year yield is probably 30 basis points too high and belongs at 2.2%. Reasons: (a) the Fed’s economic forecasts are too optimistic (remember, we just revised Q1 GDP downward yesterday from 2.6% to 1.8% after coming in at .4% in Q4). (b), the Fed wants higher inflation – 1% is too low, and finally, he makes the point that the Fed Funds rate is going nowhere until 2015 at the earliest. This anchor of Fed funds should hold down Treasuries, in his view. Color me unconvinced with that final argument – the 10 year has yielded over 4% in the context of a 25 basis point Fed Funds rate. In fact, since we have been at ZIRP, the average 10 year yield has been 2.65%. From 2009 to 2011, it average 3.25%. So, I don’t see any reason why it can’t go back to those levels. 
Insurance companies are suing HUD over the “disparate impact” rule – which says if statistically your lending to “underserved” groups doesn’t comport with the national statistics, you are guilty of discrimination, no questions asked. Here is the complaint. Of course, these sorts or analyses use FICO as the only relevant variable, which is incorrect – the volatility of prices in the neighborhood matters too. As a lender, you are short a put (if the house drops in price, the borrower can toss you the keys and walk away, yet if the house increases in price, you get the cash flow stream). That put must be priced, and you can see that the volatility of the real estate indices in places like San Bernardino is much higher than places like Milwaukee WI. Which means loans in San Bernardino should have higher rates than loans in Milwaukee WI to take into account the price of that put. It isn’t discrimination, it is the proper pricing of risk. 
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