The Manipulation of Mortgages has Begun

Introduction: First, let me give a quick course to all layman as to how mortgage professionals get paid. Banks pay mortgage brokers to take loans off their hands so to speak. Everything else being equal, the higher the rate the more the bank wants it and will pay for it for obvious reasons. In other words, for the same borrower the bank will want and pay more for a 6% rate than a 5.75% rate. There is a certain and very simple logic to this process. Keep this in mind as you chew on the big financial news of the day.

Financial industry lobbyists are urging the Treasury Department to take steps to lower mortgage rates and help stabilize the battered U.S. housing market.

Under one proposal, Treasury would seek to lower the rate on a 30-year mortgage to 4.5 percent by purchasing mortgage-backed securities from Fannie Mae and Freddie Mac, Scott Talbott, chief lobbyist at the Financial Services Roundtable, said Wednesday.

If enacted, such a plan would be an unprecedented opportunity for anyone with good credit and a solid income who could qualify for a mortgage at the lowest rates on records dating to the early 1960s, said Keith Gumbinger, senior vice president at financial publisher HSH Associates.

Yesterday, I pointed out that the Treasury's plan is another form of a price ceiling and it will eventually lead to all sorts of problems for both Fannie and Freddie which will be forced to implement it.

This brings me to developments I have seen today. The link is difficult to read but it is the rates on the standard 30 year mortgage from a bank that shall remain nameless. If you can decipher the numbers what you will see is that the bank continues to pay more for higher rates until it gets to 5.875%, then, as the rates go up it starts to pay less. Another words, some entity is giving mortgage brokers less incentive to charge anything more than 5.875%. Of course, in any real market environment this would never happen. Any bank would always want a higher rate and so every bank would continue to pay more for higher rates.

As such, the rates are being manipulated. I have looked around and most banks have some form of this phenomenon. It appears that someone doesn't want any mortgage broker to give anyone anymore than 6%. The payouts for rates are being manipulated so that there is financial disincentive to charge any higher rate than 5.875%.

Now, the rates I am talking about are those that are backed by Fannie Mae/Freddie Mac. Both entities are currently under the direction of the U.S. government. I have never until now seen this phenomenon when they were strictly private (only using government funds). As such, while I have no smoking gun proof, I would be willing to bet anything that some bureaucrat somewhere has made an executive decision and directed Fannie/Freddie to do this.

Such market manipulation is not without unintended consequences. For instance, I have been looking to do two loans each below $150,000. I was looking to lower the borrower's rates and pay for their closing costs. Rates have been manipulated so much that right now nothing pays me enough to do this. As such, these borrowers are stuck. What this sort of manipulation does is force mortgage brokers to spend even more time with borrowers with sizeable mortgages. Banks pay as a percentage of the loan amount. As such, the higher the loan amount the more the mortgage broker gets paid, everything else being equal. As such, there is already a natural bias against smaller loans. This sort of manipulation, which cuts off the natural progression of payout, creates an even larger incentive for brokers to go after larger loans. As such, whoever is doing this is essentially pricing out many folks who's mortgages are below $150,000 right out of the market.

Furthermore, this sort of manipulation will make it difficult for all those that have adjustments to their mortgage rates. Adjustments happen when something in the loan makes the loan more risky. For instance, a two unit is more risky than a house or condo and so there will be an adjustment. What banks do is take away some of what they pay the broker for this adjustments. There are adjustments for loan to value, credit score, and property disposition (primary residence or investment property). As such, any borrower with far to high an adjustment will also be aced out because no rate will pay enough to get done. For instance, let's suppose you are attempting to buy a three unit property as an investment property. The adjustments could equal three percentage points if not more. Well, what this market manipulation has done is put a ceiling as far as what the bank will pay of 1.625%. As such, someone would then have to pay about a percent and a half (and that someone would of course be the borrower) in order to get this artificially low rate. Normally, the broker would simply raise the rate to account for the adjustments but now that rates have been manipulated that won't be possible.

There is another even larger risk. It's clear that the government is going to do everything possible, manipulation included, to force rates lower artificially in an attempt to stimulate borrowing. That's all good and well for now, but what will happen to all of these banks holding onto mortgages below 6% when rates go back up? By forcing down rates and then creating a financial disincentive to go any higher than 5.875%, the government will create a much bigger demand for mortgage rates below 6% than any natural event would. Once rates go back up, and they will, then banks will have a much larger supply of low rate mortgages than they ever intended. These mortgages will be difficult to sell since they will be well below market at the time.

Furthermore, by creating this artificial ceiling, they will also force down the rates on all Fannie/Freddie bonds created by these mortgages. As such, any sucker that buys them now is buying something that is being artificially manipulated downward. Once the shackles are released, it will no doubt raise the rate on these same bonds and mean that those buying the current bonds will have been scammed. If everyone buying Fannie/Freddie bonds knew what I am seeing, they wouldn't buy them today. It's likely most of them are unaware that someone is manipulating the mortgage rates currently, and so they are buying something that is being manipulated without knowing it. This may not technically be fraud, but it has the exact same effect. How will these folks feel when they realize that the fraud perpetrated on them was created by the government? What will that do to the confidence in our investment markets?

It's truly remarkable that folks that are supposed to be experts in economics, finance, and business are doing all of this hair brain manipulation. Government manipulation of markets is what folks do in Socialist states. If we are going to be run as a Socialist state, the least the government can do is be honest about what they are doing. These sort of government manipulations like the one I see, done behind closed doors where only detailed professionals can see, is exactly the kind perverse and dishonest government behavior that I loathe. Whoever is creating this phenomenon should be made to answer. They should explain why they are doing this. The folks should know that this is happening, and instead it is being done in the worst sort of a smoke filled room type deal imaginable.

The Coming Mortgage Class War II

Last month, I described how I believed the process of government sponsored loan modifications would eventually create a mortgage class war. Loan modification is the process by which banks re negotiated loans for borrowers that are struggling to make their mortgage payments. The banks create loan terms that are more affordable to the borrower. The one loan modification I saw gave the borrower a 4% rate for 5 years, 6% for two years after than, and then 6.75% for the remainder. Keep in mind that this given only to those folks that the bank determines can't afford their current payment. The government is encouraging this behavior by both insuring modifications and in the state of California mandating they be performed before any loan can be foreclosed. Once word spreads to those that don't struggle with their payments, I believe there will be a backlash that borders on a class war.

Now, Barack Obama is determined to take us another step closer to such a class war.

President-elect Barack Obama signaled a clear desire Wednesday to use a significant portion of $700 billion in financial bailout funds to stanch foreclosures by helping struggling homeowners with their mortgages. "The deteriorating assets in the financial markets are rooted in the deterioration of people being able to pay their mortgages and stay in their homes," he said.

Obama's stance represents a policy clash with Treasury Secretary Henry Paulson, who has resisted proposals to use the rescue fund to help guarantee reworked mortgages.

...

Obama's insistence that reducing foreclosures is a key component of the rescue fund came during a Chicago news conference to introduce New Mexico Gov. Bill Richardson as his commerce secretary nominee.

"We've got to start helping homeowners, in a serious way, prevent foreclosures," he said.

So, if things go according to the plans of the federal government here is what will happen. If you can't afford your current mortgage payment, the bank will work it over to give you something that you can afford. If that isn't enough, the federal government will just give you money.

If you are able to pay for your mortgage with no help you get absolutely nothing. In fact, it will be your tax money that will go to help pay for the mortgages of people that can't afford their own. Furthermore, if and WHEN government sponsored loan modifications blow up, the interest rates of good borrowers will be increased in order to cover the bank's losses.

I have also said over and over that there is a silent majority of mortgage borrowers that are responsible and are making their payments on time. They are NOT in favor of having those less responsible than them be rewarded. The process of loan modifications is just taking off but with the next half year, it will be known by the mainstream. If Barack Obama then also insists on giving struggling borrowers cash, that will be it. A responsible borrower will be furious if and when they realize someone less responsible than them is rewarded with a loan they themselves couldn't "qualify" for. They will be even more furious once they see their tax Dollars go to subsidize the mortgage payment of those that can't make the payment on their own.

At some point people will say enough is enough. These two things combined may be the final straw. This is income redistribution through a back door but it won't fool anyone. Responsible borrowers aren't stupid. They understand that if the government is spending money and they aren't getting any that the government is then spending their money. They further understand that if the government is spending to subsidize the mortgage of those that can't pay then it is their tax money that is going to subsidize those less responsible than themselves. Everyone has enough trouble paying their own mortgage and so paying someone else's is beyond the pale. If that is the case, the mortgage class war is coming.

Treasury Plans a Very Dangerous Move

The Treasury has announced that they are developing a new plan to stem the tide of foreclosures.

The Treasury Department is considering a plan to revitalize the U.S. housing market by reducing mortgage rates for new loans, according to people familiar with the matter.

The plan, which is in the development stages, would use mortgage giants Fannie Mae and Freddie Mac to bring loan rates down as low as 4.5%, a full percentage point lower than the prevailing rates for 30-year fixed mortgages.

Now, what the Treasury is proposing is no different than any artificial price ceiling

A price ceiling is a government-imposed limit on how high a price can be charged on a product. For a price ceiling to be effective, it must differ from the free market price. In the graph at right, the supply and demand curves intersect to determine the free-market quantity and price.

Imagine if the government set a price ceiling for cars at $20,000. What this would do is create more demand for cars then there is supply. Car makers wouldn't want to make that many cars if the most they could charge was $20,000. Yet, consumers would rush out in droves to buy these cars. What this would create is a shortage of cars.

The same thing would happen here. At 4.5%, there would be no shortage of willing buyers, and refinancers if this is available for them as well. Yet, Fannie Mae would have all sorts of trouble finding folks to buy the bonds. If Fannie Mae only charges 4.5% for the mortgages, they would then have to lower the premium that they paid out on these bonds below what the market wants. In other words, if Fannie Mae were to give an interest rates on their mortgages that is below market, they would also have to give an interest rate on their bonds that is below market. On the mortgage end of it, someone is paying the rate. On the bond end of it, someone is receiving the rate in payment. So, while there would be no shortage of willing consumers ready to get these below market rates, there would be a significant shortage of willing bond buyers willing to accept that rate. That means that no one would buy these Fannie Mae bonds.

This is nothing short of a recipe for disaster. Fannie Mae would be stuck with mortgages below market and they would also be stuck with mortgage bonds below market that they simply couldn't sell. This plan is a one way ticket to ruin for the mortgage giants and since the government would have imposed this on them, it would mean yet another bailout of Fannie Mae and Freddie Mac.

I thought I had seen all I would see as far as government intervention in free markets with the bailout but this plan really is taking things to another level. Right now, we already have mortgage rates at their lowest levels in four plus years. Yet, this isn't enough for the government. They are so determined to stem the tide of foreclosures that the federal government is willing to totally disregard basic economics. There is a simple reason why all price controls fail. It creates a disequilibrium between supply and demand. In this case, there will be far more demand for the mortgages then there will be for the bonds that are created as a result. This is very basic and very simple and anyone in any basic economics class can point out why this will fail so badly. Yet, those entrusted with navigating our economy are giving such an idea serious consideration.

Brand New Council Submissions

Rhymes With Right - Something To Give Thanks About — Part III
Joshuapundit - Defeating the Death Cult
Mere Rhetoric - Former Peace Process Diplomats To Obama: Renewed Peace Process Guaranteed To Fail
The Provocateur - The Politics and Policy of Bailouts and Corporate Tax Cuts
The Colossus of Rhodey - On Delaware education
The Glittering Eye - Oars in the Water
Cheat-Seeking Missiles - Jihad’s Phony Hostages
Right Truth - P.C./D.C.
Soccer Dad - Cooties
The Razor - Use the Banks to Identify the Savages
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Submitted By: Rhymes With Right - Gateway Pundit - Magdi Allam: The Terrorism of Cut-Tongues Is More Dangerous Than Cut-Throats
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Some Context on Stimulus, Inflation and Speculative Markets

Today, John Stossel has a very good piece about the potential ramifications of all of this stimulus that the government intends on applying.

In a free market, prices do more than tell us what we have to pay for things. They are messages emitted by an intricate communications system that inform us of the relative scarcity of resources, labor and consumer goods, and the relative intensity of consumer demand. Thanks to prices, we can tell producers how we rank our preferences, and they in turn can arrange production according to our priorities. Without prices, economic coordination is impossible, which is why attempts at state planning produce, in Ludwig von Mises's words, "planned chaos".

We associate inflation with a rising price level, but equally important, relative prices change when new money is created. That garbles the messages. As Mises writes, "The additional quantity of money does not find its way at first into the pockets of all individuals; ... [P]rice changes which are the result of inflation start with some commodities and services only. ... [T]here is a shift of wealth and income between different social groups."

The Fed gives money to AIG or Citicorp, but not to Lehman Brothers, or you and me. The new bank reserves also push interest rates below what the market would have set, further distorting production by encouraging investment plans to be made on the basis of artificially low rates.How can the economy straighten itself out if it is being systematically skewed by government inference with prices?

Stossel makes two very intuitive points. First, all of this stimulus is inflationary. Second of all, it is skewed inflationary toward one group at the expense of other groups.

These two points should be viewed in the context of the last time the government provided so much stimulus, 2002-2003. At that time, I believe that the Fed provided far too much artificial stimulus when it lowered the Fed Funds Rate below 1%. This artificial stimulus caused banks to borrow far more money than a natural market would have wanted, and this created, in my opinion, the speculative market that lead to the mortgage crisis. Sometimes, we don't recognize just how inflationary a stimulus is exactly because the inflation becomes isolated in or a few sectors. That's exactly what happened with the Federal Reserve's stimulus. From 2003-2006, we saw an explosion in real estate prices. Things varied but on average prices went up about 50% in that time period. Most folks didn't see this as inflation though in fact that's exactly what it was and the inflation was mostly isolated in the value of real estate.

This massive inflation in real estate was part and parcel wrapped up in the speculative nature of the market for real estate. All of this was created by the artificial stimulus of the interest rate cuts. In that event, those that happened to buy into real estate were the winners of this inflation but everyone else that didn't take advantage lost out. During that four year period, many people became priced out of real estate.

Of course, currently we are looking at even more inflationary stimulus and once again the stimulus is isolated. Stossel very intuitively points out that folks like AIG, Citigroup, and the autos will be the beneficiaries of the bailout. So, where all of these folks that are the recipients of the stimulus put that money that will be the market that will see inflation. Furthermore, and much more importantly, because this stimulus is so massive it is likely to cause whatever market is the beneficiary to invariably become speculative. Too much stimulus almost invariably leads to a speculative market wherever that is applied.

What all of this stimulus will eventually do is create disequilibrium in some niche or market. That market will show signs significant potential income and every quick buck artist will begin putting their money there, and we are on a path for another catastrophe created by another speculative market.

Make no mistake the sort of stimulus the government has and will create is unprecedented. We are about to drop about $700 billion into one sector. The kind of stimulus that financial services is about to receive is unprecedented. Furthermore, the Fed Funds Rate currently is 1% and most expect it to go lower and possibly all the way to zero. As such, not only will financial services be flushed with all sorts of cash but they will have access to very loose credit. This is in fact exactly what stimulated the speculative market that caused this mess only the last stimulation was minuscule compared to what we are about to see. By every indication, we are now creating another speculative market to blow up in the next five years.

Obama and the T Bond Albatross=Gasoline to a Flame

I just wrote about the albatross about to form involving the Treasury Bond and the bailout(s). The Treasury Bond is at record levels and only giving an interest rate of 2.67% on the ten year benchmark. At the same time, we are trying to borrow several trillion Dollars. In other words, we are asking debtors to lend us several trillion dollars even though they would only get 2.67%, at least currently, as their rate. The Treasury bond, especially the ten year, is the pre cursor to most long term rates like mortgages, car loans, student loans, etc. so it's uncontrolled volatility could wreck havoc in all sorts of places. This is a potentially nuclear combination and if Barack Obama handles it wrong it will be like pouring gasoline on a flame.



Unfortunately, so far all indications are that he will likely do the exact wrong thing. He wants a major stimulus right away. They are talking about $500-$700 billion and he still will likely have half of the current stimulus to spend (not to mention that Obama maybe forced to bailout the autos if President Bush doesn't and he now wants to bailout cities and states) In order to do this right, he wants borrow a little at a time on a regular schedule. That way the stimulus from your purchases will be mild at any given time. It also gives the President the ability to monitor what effect his massive borrowing will have on the Treasury bond market. Instead, he is likely to request a bunch and have the Treasury get it for him almost as soon.



The possibilities for disaster if this is done wrong are enormous. There are all sorts of technical scenarios that could be frightening. For instance, there is something known as moving averages. If any investment, of which the Treasury bond is one, takes off in any direction and continues up staying above a certain level it will continue to go up until it breaks through the plane of the so called moving average. In other words, if Barack Obama does it wrong it will ride up for a while and soon the Treasury bond will be holding records only the other way.

If he dumps too much it could shock the system in all sorts of ways. If someone is NOT aware of the fury they are about to unleash all sorts of bad things are possible. Frankly, everything is already volatile and now Barack Obama has an opportunity to explode as volatile a potential combination as I have seen in a while.

The sort of fluctuating interest rate market he could create would make it nearly impossible to do any business especially with the situation as it is. Imagine if banks are locking loans and the rates are a full percentage point higher the next month. In fact, that's how a lot of pseudo banks went out of business back in the end of 2003. Rates went up like crazy and by the time they were able to sell they weren't making enough to get by.

Finally, it will almost certainly make interest rates bad enough that the real estate market won't have a chance to get better. Imagine if several hundred billion Dollars worth of new bonds are issued within three months. That could cost at least a full percentage point to the mortgage rates. If it's handled poorly we could easily see rates at 8%.

The first test of Barack Obama's effectiveness in carrying out the bailout is his ability not to stimulate the Treasury bonds when he borrows the money. I hope I am wrong but so far I anticipate an unmitigated disaster.

The Record Yield on the T Bonds and the Bailout(s)

In the last couple days we have seen Treasury bond YIELDS reach record levels.

Treasuries rose, pushing yields to record lows, as Federal Reserve Chairman Ben S. Bernanke said the central bank may purchase Treasuries and target long-term interest rates to combat the deepening recession.

Bonds rallied for a fourth day, sending yields on two-, 10- and 30-year debt to the lowest since the Treasury began regular sales of the securities. Bernanke said he has “obviously limited” room to lower interest rates further and may use less conventional policies, such as buying Treasury securities. The panel of economists charged with dating business cycles said the U.S. entered a recession in December 2007.

“Cash and Treasuries are king,” said Barr Segal, a managing director at Los Angeles-based TCW Group Inc., who oversees $90 billion in fixed-income assets. Bernanke “wants everybody to know he has more options. Some are more effective than others.”

With it, mortgage rates have now seen levels not seen in years.

U.S. mortgage rates plunged by the most in at least seven years yesterday as a Federal Reserve pledge to buy $600 billion of debt succeeded where seven cuts in the central bank’s benchmark rate had failed.

The average rate for a 30-year fixed mortgage fell to about 5.5 percent last night after starting the day at 6.38 percent, according to an estimate from Bankrate Inc. It was the biggest one-day drop in at least seven years, said Holden Lewis, of the
North Palm Beach, Florida, publishing and research firm. Today, the rate is “bouncing around” between 5.63 percent and 5.9 percent, he said.

All of this is excellent medicine as mortgage applications increased as well.

The Mortgage Bankers Association (MBA) today released its Weekly Mortgage Applications Survey for the week ending November 21, 2008. The Market Composite Index, a measure of mortgage loan application volume, was 404.4, an increase of 1.5 percent on a seasonally adjusted basis from 398.6 one week earlier. On an unadjusted basis, the Index decreased 1.0 percent compared with the previous week and was down 21.9 percent compared with the same week one year earlier.

I have said over and over that another mini refinancing boom is just about the only thing I see that can pull this economy up in the short term. Without it, we are in for a very difficult economic time.



That said, while record Treasury Yields have produced some welcomed short term economic news, they may spell some potential trouble ahead. Much of the bailout money, both already allocated and still to be allocated, hasn't been borrowed yet. Most of it still has to be borrowed and that's what Treasury bonds are for. The yield works inverse of the rate on the bonds. Right now, the Treasury bond is at a record low rate of 2.67%. In other words, we are about to dump another roughly one trillion Dollars worth of Treasury bonds on the market and we are hoping to find investors willing to accept a return of 2.67% per annum for them.



While Treasury bonds are certainly not supposed to ever yield any sort of an aggressive return, clearly there is room for significant problems here. First, we have the nightmare scenario. With the rates on Treasury bonds paying that low, there is an outside chance that they simply won't sell. In such a case, the U.S. government will begin defaulting on its debt. We may have to go into bankruptcy and our time as a superpower will end.



More likely though is that the yield on these bonds will drop significantly and pull the rate up to a more reasonable level for adding another trillion Dollars worth of debt. In such a scenario, the first big loser is anyone currently holding the bonds paying what they are paying. The second big loser is the housing market and the economy with it as all long term rates, mortgage rates included, will go up. The third big loser will be the U.S. government since they will have to pay a significantly higher interest on their debt than they are currently. (though this is a loss of their own doing) In any scenario though, we have yet to see the pernicious effects of the bailout, but clearly we are all about to find out just how devastating it is to borrow as much as our government is planning on borrowing.