Reply #1: Market WrapUp: Farewell to ARMs

[ozymandius]

BY BRIAN PRETTI

It was a bit funny last month watching Fannie Mae and Freddie Mac stock prices squirt higher on the assumption/rumor that F&F would act to basically bail out or monetize at least some portion of troubled US mortgage paper. Let’s be frank with each other; there is absolutely no way on this green Earth F&F could make this happen, despite the fact that they had in the past been key credit cycle provocateurs when needed most to provide systemic liquidity in the late 1990’s. The regulators have been all over Fannie and Freddie in recent years. These two need to petition the regulators at this point to expand their balance sheets. Importantly, one day after such a request from Fannie to expand conventional lending limits, the OFHEO turned down the request without even blinking. Any questions? The numbers simply don’t add up for these two to even make a dent in the hundreds of billions in mortgage paper that either is now or will become troubled ahead. These GSE’s simply are not going to be of significant credit market help this go around, despite the fact that I’m sure a number of politicians will try to override the OFHEO. But what is very helpful is the fact that our friends at Freddie so kindly give us a glimpse into the world of mortgage refinancings now and again. I’m sure you are more than aware that from literally this month all the way through the summer of next year, we are going to see the largest number of adjustable rate mortgages resetting in this country that we will probably ever see in our lifetimes. The peak comes next March. As I’ve mentioned many a time, household mortgage issues of substance and the ultimate consequences of this circumstance lie ahead of us, not behind us.

So if you don’t mind, in relatively rapid-fire fashion, let’s quickly review the most recent mortgage refi data as of 2Q 2007. Important why? It’s an insight into consumer behavior, and I believe an insight into levels of financial stress at the household level. The charts tell the story. There are plenty of them, so let's roll through them. Please remember when looking at this data that the real crunch in mortgage credit availability has occurred in the third quarter of this year, not the second. This data only runs through 2Q, so in many senses it may indeed be the final hurrah. A farewell to ARMs of sorts. As examples, both WAMU and Wells, two of the largest players in the sub prime game, shut their sub prime lending operations down last month, not during 2Q. American Home Mortgage imploded in August, not in 2Q. You get the picture. Since 2Q period end, residential mortgage terms and credit availability have tightened up significantly. Let’s get right to it and have an initial look at level of cash out refi’s through the second quarter. As is clear, 83% of all refi transactions involved a new loan at least 5% higher than the prior loan in 2Q. Implication? At least as of the second quarter, households were implicitly continuing to lever up the largest household asset that is clearly declining in value. Do you really think these were choices households wanted to make? Or were forced to make? In case you have not heard, NEVER in US history have we experienced year over year declines in home prices without being in a recession or depression. Does this help frame the character of these actions?

http://www.financialsense.com/Market/wrapup.htm