All Things in Moderation

Vital Statistics:

Stocks are higher on no real news. Bonds and MBS are flat.

The Trump administration released a set of principles around privatizing the GSEs. It is more or less the same thing as before – the goal is to lessen the government’s footprint in the mortgage market. The idea would be to have Fannie and Fred issue MBS with a catstrophic government guarantee – in other words, some private mortgage insurer would bear the initial losses and the government would only step in if the losses exceeded that number. That is all well and good, however there are all sorts of issues that remain before private label MBS can do the heavy lifting of the mortgage market.

First and foremost, there is a huge gulf between what the MBS investor market requires as a rate of return and current mortgage rates. In a perfect world, PL MBS would trade at similar levels to Fannie / Freddie MBS, but they won’t. There are huge governance issues that need to be resolved. For just one example, will the servicer (who is probably the issuer, who may also have a second lien) service the loan to benefit the MBS holder or themselves? What about reps and warranties? I went into more depth about this whole issue here. These uncertainties need to be priced in, which means that the bid / ask spread between private label and FNMA MBS is so large that nobody would take out a mortgage at the rate the private label investors require. That is a necessary but not sufficient requirement to bring back private money into the US mortgage market.

Taking the GSEs out of conservatorship is going to require legislation, and to be honest it isn’t a priority for either party. As far as DC is concerned, yes it would be nice if the government could lessen its footprint in the mortgage market, but people are getting loans, and the market is functioning normally. It just isn’t a priority.

The US borrower believes that the 30 year fixed rate mortgage is nothing unusual. In fact, it is a distinctly American phenomenon, where the borrower bears no risk. In the rest of the world, mortgages are adjustable rate, and not guaranteed by the government. In other words, the borrower bears the interest rate risk and the bank bears the credit risk. In the US, the bank bears the interest rate risk and the taxpayer bears the credit risk. Upsetting that apple cart is going to be a tough slog politically.

Finally, the news did nothing for the stocks of Fannie and Fred, which continue to languish. When the government took over Fannie and Fred, they left 20% of the common outstanding. This was an accounting gimmick to prevent the government from having to consolidate Fan and Fred debt on its balance sheet (incidentally, this was the reason why LBJ privatized the GSEs in the first place). The government could not take the GSEs through a bankruptcy without creating chaos in the mortgage market. So they left 20% outstanding and decided to deal with the bankruptcy part later. The stock should be worthless, but it is a litigation lottery ticket.

A Federal Judge ruled yesterday that the CFPB’s structure is unconstitutional. The PHH case never made it to SCOTUS, but it will be interesting if this one does. At some point, the CFPBs structure will make it to SCOTUS, and the only one with the standing to defend the agency is the government.

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Vital Statistics:

Stocks are flattish this morning on no real news. Bonds and MBS are up small.

Initial Jobless Claims fell by 3,000 to 218,000, while the Index of Leading Economic Indicators increased by 0.2%, below expectations. This index is predicting that growth will moderate in the coming months. Note that Goldman has taken its Q2 GDP estimate up to 4%, which is a torrid pace.

Mortgage Applications rose 5.1% last week as purchases rose 4% and refis rose 6%. Mortgage rates were more or less unchanged for the week.

Existing Home Sales fell 0.4% last month to a seasonally adjusted annual rate of 5.43 million. Existing Home Sales are down 3% on a YOY basis, making this the third consecutive month with a YOY decline. The median house price hit a record, rising 4.9% to $264,800. While restricted supply has been an ongoing issue, the market is beginning to feel the pinch of rising rates and prices. The first time homebuyer accounted for 31%, which is a decrease and well below the historical norm of 40%. At current run rates, we have about 4.1 month’s worth of inventory. Some realtors noted that potential sellers are pulling their homes off the market for fear they won’t find a replacement. We need a dramatic increase in home construction to fix the issue and so far we are seeing modest increases.

Speaking of home price increases, the FHFA reported that prices rose 0.1% MOM in April and are up 6.4% YOY. Since the FHFA index ignores jumbo and non-QM, this is prime first-time homebuyer territory. Home price appreciation is beginning to converge as the laggards like the Mid-Atlantic (which covers NY and NJ) are picking up steam. The dispersion a year ago was huge.

CoreLogic estimates that a third of all MSAs are now overvalued. The last time we hit this level was early 2003, just before the bubble hit its stride. It is natural to ask if we are in another bubble, and IMO the answer is “no.” The term “bubble” gets thrown around so much that it has lost its meaning. The necessary conditions for a bubble (magical thinking on the part of buyers and the financial sector) just aren’t there. China has a bubble. Norway has a bubble. The US does not.

The US coastal and Rocky Mountain areas have the most overvalued residential real estate, but aside from that it is still cheap / fairly valued elsewhere. Either the overvalued MSAs will start building more homes, or the employers in those MSAs will begin to move more operations to cheaper areas. You can see that already with Amazon.com de-emphasizing Seattle. Some MSAs become to cheap to ignore (the Rust Belt, for instance) and others become so expensive that companies cannot attract entry-level talent anymore. For a hotshot MIT data scientist, working at Google or Facebook sounds very cool, but if you can’t afford an apartment are you really going to be willing to work there?

Foreclosure starts fell in May to 44.900, which is a 17 year low. The foreclosure rate of 0.59% is the lowest in 15 years. At the current rate of decline, the foreclosure inventory is set to hit pre-recession levels later this year. The Northeast still has a foreclosure backlog to deal with, but the rest of the country has moved on.

HUD is asking for public input into its disparate impact rules, which were dealt a blow at SCOTUS. Disparate impact is a highly controversial legal theory that says a company is guilty of discimination even if they didn’t intend to discriminate – if the numbers don’t match the population the lender is guilty, no questions asked. That theory was dealt a blow with a 2015 ruling that said the plaintiff must be able to point to specific policies of the lender that explain the disparate impact. HUD is now looking to tweak the language to conform to this ruling.

Incoming CFPB nominee Kathy Kraninger is getting some static from Democrats due to her position at DHS. They are asking questions about her role in the zero tolerance policy and child separations. Elizabeth Warren is putting a hold on her nomination until she answers these questions. That may not be a disappointment to the Administration however. The gameplan may be to slow-walk a new CFPB nominee in order to keep current Acting CFPB Chairman Mick Mulvaney at the helm of the agency.

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Vital Statistics:

Stocks are lower this morning on trade fears. Bonds and MBS are up.

We will get a lot of housing-related data this week, but nothing should be market-moving. We will get housing starts and building permits tomorrow, existing home sales on Wednesday, and house prices on Thursday. Otherwise, should be a relatively quiet week.

The NAHB Housing Market Index (a sentiment indicator for the homebuilders) fell to 68 last month from 70. Rental markets are softening in some of the more pricy MSAs.

OMB official Kathy Kraninger is supposedly the front-runner to replace Mick Mulvaney as the permanent director of the CFPB. The confirmation process will probably take at least through the end of the year. She is not viewed as any sort of financial regulatory expert, so expect to see a lot of objections from Democrats over the nomination.

Ben Bernanke thinks the US economy will have a Wile E Coyote moment in 2019 or 2020 when the tax cut stimulus wears off. His point is that we are enacting fiscal stimulus at “exactly the wrong time” when the economy is already at full employment. Of course the statement about full employment is debatable. The unemployment numbers indicate we are, but the employment-population ratio does not. The employment-population ratio currently stands at 60.4%, and pre-crisis, we were around 63%. That 2.6% difference works out to be about 8.5 million people. We are getting some modest real wage growth (average hourly earnings are up 2.7% YOY and the core PCE index is growing at 2%) however broad-based wage growth probably isn’t going to happen until the EP ratio gets back up around 63%. Yes, there is a demographic element to this with the baby boomers retiring, but that is overplayed. Many people who are retiring in their 60s would rather work. You can see just how bad the Great Recession was. Most of the gains that started in the 60s with women entering the workforce were given back. The “retiring boomers” narrative has a kernel of truth in it, but it isn’t driving it.

The FAANG stocks are now worth more than the entire UK stock market. While people talk about short Treasuries as being the most crowded trade on the Street, it doesn’t hold a candle to the FAANGs

Goldman’s model now suggests the US economy grew at 4% in the second quarter. Friday’s Empire State Manufacturing Survey was the catalyst for the upgrade.

The government is trying to clarify the Volcker Rule, which prohibits banks from proprietary trading. So far, it seems to be clouding the issue as opposed to clarifying it. Ultimately trades held for less than 60 days are considered proprietary trades although there is a carve-out for hedging and market-making. Given the drop in commissions over the past 20 years, and sub-penny bid ask spreads, the economics of market-making are terrible to begin with, but the regulatory uncertainty probably seals the deal. The next crash is not going to be pretty.

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Vital Statistics:

Stocks are higher after the FOMC raised interest rates a quarter of a point. Bonds and MBS are up.

As expected, the Fed raised the Fed funds rate by 25 basis points to a range of 1.75% – 2%. The economy is clicking on all cylinders, with unemployment down, consumer spending up and business investment increasing. They took up their estimates for 2018 GDP growth to 2.8% from 2.7%, took up core PCE inflation to 2% from 1.9% and took down their unemployment rate forecast to 3.6% from 3.8%. The dot plot was increased slightly and the Fed funds futures shifted to a 60/40 probability of 2 more hikes this year.

Bonds initially sold off on the announcement, touching 3% at one point, but have since rallied back. The ECB also announced that it will stop buying bonds in September, depending on the data. Bunds are rallying on that statement and the 10 year could be rallying on the relative value trade. The Fed noted that longer-term inflation expectations have not changed, and they didn’t change their outlook for inflation from 2019 onward. One other thing of note: the Fed is going to start having press conferences after every meeting in order to disabuse people of the idea that the Fed can only hike in December, March, June and September.

In other economic news, initial jobless claims fell to 218,000 last week, while retail came in way higher than expected, rising 0.8% for the headline number and 0.5% for the control group, which excludes gasoline, autos and building materials. Restaurants and apparel were the big gainers, increasing 1.3% and 1.5%. Consumer discretionary spending is back, as the FOMC statement indicated.  Finally, import and export prices were higher than expected, with increasing energy prices pushing up imports and higher ag prices increasing exports.

Outgoing Republican Congressman Darrell Issa is supposedly one of the finalists who will be appointed as the head of the CFPB. The Administration has said that it will abide by its June 22 deadline to appoint a permanent head of the CFPB. Acting Chairman Mick Mulvaney is not involved in the selection process. Mark McWatters, a former banking regulator is another top choice, and probably makes more sense than Issa.

The May real estate market was the strongest on record, according to Redfin. Prices rose 6.3% and the average home was on market 34 days. In Denver, the time on market was under a week. Over a quarter of the homes sold in May went over their listing price. San Jose saw a price increase of 27% YOY to a median home price of over $1.2 million.

Note that rents rose by 3.6%, which is tilting the rent-vs-buy decision a little. Interestingly, Sam Zell, a famous real estate financier, thinks the multifam market is topping and should become less attractive going forward.

Affordable home advocates are touting a statistic that shows a minimum wage worker cannot afford a 2 bedroom apartment anywhere in the country. That is an awfully high bar – heck entry level investment bankers can’t afford a 2 bedroom apartment either. That is why young adults usually have roommates. I get there is a shortage of affordable housing, but that is a completely disingenuous statistic. Sam Zell is probably correct, however there could in fact be a glut of luxury apartments and a shortage of affordable ones.

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Vital Statistics:

Stocks are higher as we await the FOMC decision. Bonds and MBS are flat.

The FOMC decision is set to come out at 2:00 pm EST. Investors are going to probably focus most closely on the dot plot to get a sense of whether we get 1 or 2 more hikes this year. Generally speaking, the dot plots have been a bit more hawkish than the Fed Funds futures market.

Inflation appears to be picking up at the wholesale level (kind of echoes what we were seeing yesterday in the NFIB Small Business Optimism report). The Producer Price Index rose 0.5% MOM / 3.1% YOY, which was higher than expectations. Much of the pressure came from higher energy prices. Trade (which is a function of the dollar) was the other catalyst. Ex-food and energy, prices rose 0.1% MOM / 2.6% YOY. The Fed does pay attention to this number, however the PCE index is their preferred measure of inflation, and it is sitting close to their target.

Mortgage applications fell 2% last week. Both purchases and refis fell by the same amount.

Mortgage Credit Availability rose in May by 1.5% as a dwindling refi market is encouraging originators to widen the credit box. While the index has been steadily rising since 2011 when it was benchmarked it is nothing like the bubble, where credit was orders of magnitude tighter.

The business press warns that liquidity is going to dry up during the next crisis. While Dodd-Frank claims to allow market making (and not proprietary trading), there is no doubt that banks are going to be completely uninterested in sticking their necks out during the next sell-off. Even worse will be ETF investors who think an exchange traded fund gives them a liquidity risk “free lunch”. (It isn’t like I am investing in junk bonds – I am investing in an ETF that invests in junk bonds – its different!) When the underlying assets of that ETF go no-bid, so will the ETF.

Ever wonder why servicing values in states like NY, NJ, and CT are so low? The foreclosure process can stretch out for years. In this case, the occupants made their last payment in June 2010.

Speaking of the Northeast, all real estate is local as they say. While the West Coast sees sales close in weeks, luxury properties languish for years in the Northeast. The tony NYC suburb of New Canaan, CT has banned “for sale” signs, because there are too many of them (although the excuse is that people shop on line). There is definitely a bifurcation line in the NYC suburbs – below $750k you can move the property, above that good luck. And $1.5 million or more, forget about it.

From the NAHB: rental inflation is moderating. Meanwhile, home equity hits a new high.

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Vital Statistics:

Stocks are higher this morning on reports of an agreement with North Korea. Bonds and MBS are down.

The FOMC meeting begins today. The Fed Funds futures are handicapping a 91% chance of a rate hike tomorrow.

Trump and Kim signed an agreement to denuclearize the Korean Peninsula. There is no timetable, but not much in the way of concrete agreements, however Trump did pledge to end military exercises with South Korea.

Inflation at the consumer level remains under control, as the Consumer Price Index rose 0.2% MOM / 2.8% YOY. The core rate rose 0.2% MOM / 2.2% YOY. These numbers were all in line with street estimates. Aside from energy, healthcare costs (hospital, Rx) drove the increase.

Small business optimism remains strong, as the NFIB index hit its second highest level in its 45 year history. Compensation increases hit a 45 year high as a net 35% of small businesses increased wages. 58% of employers reported openings, but half couldn’t find qualified applicants. I will say this again, I suspect the biggest culprit in the “labor shortage” is the plethora of application tracking systems which pre-screen job applications. They may have been a help during the days of high unemployment when finding the right employee was like finding a needle in a haystack. Nowadays, they the computer systems are probably screening out potential fits before anyone gets to see the resume. There are all sorts of articles about how these systems have to be gamed, and most people probably don’t.

The strong economy and good home price appreciation are contributing to a drop in delinquencies, according to CoreLogic. 30 day DQs dropped by 10 basis points to 4.3% in March. The foreclosure rate fell from 0.8% to 0.6%. In the first quarter, the typical homeowner saw a $16,300 increase in home equity.

Declining margins has lenders bearish, according to the latest Fannie Mae lender sentiment survey. “Lenders remain bearish this quarter as they continue to face headwinds from rising mortgage rates, tight supply, and strong home price appreciation, which have drastically reduced refinance activity and restrained home purchase affordability,” said Doug Duncan, senior vice president and chief economist at Fannie Mae. “These factors have combined to squeeze mortgage origination volumes and have increased competitive pressures. Increased competitiveness will likely persist as a top driver of lenders’ mortgage business strategy. We expect this will prompt businesses to turn to cost-cutting as a means of managing their bottom lines, with payroll reduction likely to assume a more prominent role in future belt-tightening efforts.”

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Vital Statistics:

Stocks are flattish this morning ahead of a busy week. Bonds and MBS are down small.

This is a big week with the FOMC meeting on Tuesday and Wednesday, the ECB, and also a slew of economic data, particularly inflation data. The FOMC meeting will dominate, and we will also get a fresh new set of projections. The Street will focus on the inflation projections, especially as we continue to get anecdotal evidence of wage inflation.

The G7 met over the weekend, and it largely consisted of Donald Trump playing Al Czervik to the Bushwood global elite. There is talk about us doing permanent damage to our allies, but these events are largely messaging affairs and nothing much concrete ever comes out of them. There were a bunch of threats and counter-threats over trade barriers, and the message from the Administration was that the US has historically accepted the short end of the stick on these trade deals in the name of free trade in general, but those days are over. Will anything actually come from this? Probably not, which is why the markets don’t care.

Trump left the G7 meeting early to head to the Singapore Summit to meet with Kim Jong Un.

CFPB Director Mick Mulvaney said on Friday that he fired the 3 advisory boards because they were simply too big. He said that many participants were uncomfortable being candid at these meetings, and that “There is actually some good information that can pass when you sort of turn the cameras off.” Mulvaney has also been frustrated by leaks coming out of the agency, and he hopes this will help. Mulvaney also intends for the CFPB to go out “in the field” and have more town hall discussion meetings.

The interest rate on excess reserves is a real “inside baseball” statistic that could hold some clues on how the Fed intends to proceed going forward. The Fed is worried that conditions are tightening in the money markets and there are less excess reserves (excess reserves in another name for “dry powder” in the banking system). If there is less dry powder (or lending capacity) in the system then borrowers will have to accept higher rates in order to access these funds. The Fed funds rate is already close to the high end of the target range, which is worrying the some on the FOMC. The Fed started unwinding its QE balance sheet, letting about $100 billion of its $4.5 trillion sheet run off. We are already seeing a swoon in emerging markets. Bottom line: tightening financial conditions could cause the Fed to take a breather sooner than anticipated.

Rising interest rates and home prices are not deterring potential home purchasers, as the Fannie Mae Home Purchase Sentiment Index hit a new high in May. “The HPSI edged up to another survey high in May, bolstered in part by a fresh record high in the net share of consumers who say it’s a good time to sell a home. However, the perception of high home prices that underlies this optimism cuts both ways, boosting not only the good-time-to-sell sentiment but also the view that it’s a bad time to buy, and presenting a potential dilemma for repeat buyers,” said Doug Duncan, senior vice president and chief economist at Fannie Mae.

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Vital Statistics:

Markets are lower this morning on negative news out of Apple. Bonds and MBS are down small.

Something to watch: We are seeing bigger bets against emerging markets currencies and some European bonds. These trades will bump up against Treasury shorts, which were increased last week in the wake of the Italian election results. One of the biggest trades in the hedge fund community is short Treasuries – which means hedge funds are betting on rising rates. A sell-off in Euro bonds and emerging markets will add buying pressure to Treasuries on the flight to quality trade. So, expect some volatility in Treasuries as fast money enters and exits the market.

Rising interest rates are creating another phenomenon – increased flows into money market funds. Money market funds had been a moribund asset class after the crisis, with interest rates at 0% and the memories of breaking the buck still fresh in many investors minds. Money market funds are seeing the biggest inflows since 2013. Expect to see more of this as bond investors also look for ways to shorten duration. This is yet another reason why hedge funds are short Treasuries.

After the Italian led drop in rates, the market adjusted its prediction for the Fed Funds rate. Still sitting at a 60-40 bet for 3 or less hikes this year / 4 or more.

Warren Buffett and Jamie Dimon are exceedingly bullish on the US economy. “Right now, there’s no question: It’s feeling strong. I mean, if we’re in the sixth inning, we have our sluggers coming to bat right now” is how Warren Buffet characterized it. Jamie Dimon’s view: “The way I look at it, there is nothing that is a real pothole,” he said. “Business sentiment is almost at the highest level it’s ever been, consumer sentiment is at its highest levels, markets are wide open, housing’s in short supply and my guess is mortgage credit will expand a little bit.”

Buffett and Dimon are also arguing for companies to stop providing earnings guidance. They claim that focusing on short term quarterly earnings causes companies to de-emphasize long-term growth. Berkshire Hathaway does not provide any sort of guidance to the Street. It is an interesting idea, however companies provide guidance to the Street because investors as a general rule prefer predictable companies to unpredictable ones.

How not to “teach your servicer a lesson.” Yikes. If you think your lender is making a mistake, or you are unhappy with the service, don’t stop paying as a means of retaliation.

The OCC is taking a more constructive approach with the banks. At the top of the agenda: re-writing community reinvestment rules to be less onerous for the industry. Obama’s head of the OCC was a career regulator who made a point of challenging the perception that the OCC was too close to the banks it regulated. The Obama administration pushed hard for banks to take less credit risk, and I wonder how much of the issue with a lack of housing construction is due to that. While this wouldn’t affect the Lennars of the world, most construction is with smaller builders who would have to go to their local community bank for financing.

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Vital Statistics:

Stocks are higher this morning as trade tensions with China ease. Bonds and MBS are lower.

Initial Jobless Claims fell to 222k last week. We are still bouncing around lows that we haven’t seen since the Vietnam War.

Changes are afoot at the CFPB. First, Mick Mulvaney dismissed all 25 members of the Consumer Advisory Board in order to cut costs and increase the diversity of voices. The Community Bank Advisory Board and the Credit Union Advisory Board were also terminated. Apparently, these committees were traveling to DC on taxpayer expense. Many of these people are simply professional political activists in the business of raising money for liberal candidates, and were often given funds from settlements – in other words, it was a bit of a political money-laundering operation. So, there is no reason for an agency under a Republican Administration to fund the Democratic political machine. Also, the Obama / Cordray CFPB was one-sided – they listened only to consumer advocates and had zero interest in input from the industry. For better or worse, you make better policy when you have input from the people who will be affected by your rules and regulations.

Separately, the CFPB is prepared to dismiss its case against PHH. The PHH case is a tricky one, where the CFPB unilaterally increased a judge’s $6 million penalty to $106 million. PHH won a big victory last January when an appeals court threw out the judgement. There structure of the Agency was also brought into question during this case, which helps explain why the CFPB is anxious to make this case go away.

Independent mortgage bankers lost money on average in the first quarter, according to the MBA. Net production losses were $118 per loan (or about 8 basis points). The last time we saw something similar was the first quarter in 2014. The first quarter is always a seasonally weak period.  Declining volumes, increasing costs, and thinner margins are driving the losses. Net secondary marketing income was more or less flat, and purchases accounted for 71% of the volume. Pull-through rates fell to 70% from 74% in the fourth quarter. Production expenses and personnel expenses increased quite a bit, to almost $9,000 a loan. That number has been closer to $6,200 since 2008. Productivity also fell to 1.9 loans per employee from 2 loans in the fourth quarter.

Chinese money has been pushing up real estate prices in many cities, from Vancouver to Seattle, to Sydney. Local governments are finding more and more of their citizens are being priced out of the market and are trying to do something about it. In Vancouver, prices were appreciating at an annual rate of 30% before the government imposed a foreign investments tax. The money then left and moved to Toronto. Ultimately probably nothing will change until the Chinese real estate bubble bursts, and no one has any idea when that will happen. One thing is for sure, however. When the bubble does burst, these cities will get hit first. In a financial crisis, you sell what you can, not what you want to.

How easy is credit these days? Twitter is offering $1 billion in convertible bonds paying 25 basis points of interest that convert into Twitter stock at a 44% premium to the current share price. That is as close to free money as you are going to get.

Apparently the market cap of the FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google) is now higher than the GDP of Germany. Most crowded trade since the Nifty 50 in the 1970s.

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