Tuesday, Aug. 25
Posted 11 a.m. Eastern

Obama to Reappoint Bernanke

President Obama has decided to nominate Ben Bernanke to a second four-year term as Chairman of the Federal Reserve Board. Regardless of whether you believe Bernanke deserves another term or not, resolving the uncertainty as to who will be at the helm of the Fed is a good thing and especially when done early, like in this case. (Bernanke's term doesn't expire until Jan. 31.)

The economy is still in a critical phase with the recession coming to an end but weak recovery prospects due to rising unemployment and anemic growth in household income. The Fed is also going to become increasingly relevant to the path of long-term interest rates as they wind down $300 billion in Treasury purchases and decide whether their 2010 purchases of Fannie and Freddie mortgage-backed securities will come anywhere close to the $1.25 trillion done this year.

Bernanke is still subject to Senate confirmation.

Keeping Bernanke as Fed Chairman will allow the Fed to focus on the actual work of unwinding liquidity programs. Eventually the Fed will begin to raise short-term interest rates but we are still a long-way from that. Whether or not they will ultimately have the fortitude to do so in the face of political pressure to keep rates low is a topic for another day.

Wednesday, Aug. 12
Posted 4 p.m. Eastern

Fed to wean markets from Treasury buybacks

As expected, the Federal Open Market Committee left short-term interest rates unchanged and used the same exact language to indicate it will be quite a while before it raise rates. There were, however, two notable remarks in today's Fed meeting statement.

The first pertains to the broad economy, with the Fed saying that "economic activity is leveling out." The significance of the switch represents a shift from things-are-getting-bad-at-a-slower-pace to we've-hit-bottom.

Secondly, the Fed did address the $300 billion Treasury buyback program slated to expire in September. The Fed appears to have found some middle ground between continuing the program and adhering to the original timetable. The Fed will slow the pace of the purchases so that the buybacks cease by the end of October rather than in September.

Is this good news? Well, it is better than quitting cold turkey in another month, but it won't do much to rein in interest rates if economic data continues to improve or inflation concerns ignite.

Let me put this in a bit of context. The Fed has already purchased $250 billion out of the $300 billion slated for the program. They didn't increase the amount -- they'll still buy the remaining $50 billion but take an extra month to do so. But it will be of limited help in reining in interest rates because the Treasury continues to increase the amount being issued. Just today, the Treasury issued $23 billion, on top of the $37 billion yesterday and will do another $15 billion tomorrow. So the Treasury issued more debt in the past day and a half than the Fed will buy back in the next two and half months.

The Fed also deferred any mention about mortgage-backed securities buybacks, which total $1.25 trillion out of $2 trillion in expected total mortgage originations this year. That is the big kahuna in terms of impact on mortgage rates -- but we'll wait until September, November or December to get any details.

Saturday, Aug. 8
Posted 8 a.m. Eastern

Fed's Game Plan Needs to Take Form

The Federal Open Market Committee meets Tuesday and Wednesday, Aug. 11-12, with an announcement expected Wednesday around 2:15 p.m. ET. But an announcement of what? The Fed remains eons away from raising short-term interest rates, but the time has come for the Fed to be more specific about what they intend to do as the economic recovery continues.

Economic output, as measured by Gross Domestic Product, appears to have bottomed in the second quarter and a resumption of economic growth is now underway. After a long and deep recession, a great deal of economic growth must be seen in the next siz to eight quarters in order to claw back what has disappeared since the fourth quarter of 2007. The unemployment rate will keep rising, notwithstanding the slight decrease in July, but it is definitely a marker of progress that employers are cutting jobs at a much slower pace than what was seen just a few months ago.

In the post-meeting FOMC statement, expect the usual cautionary statement that "conditions continue to warrant exceptionally low levels" in the federal funds rate to be maintained. After all, increasing joblessness, weak growth in household income and the reluctance of consumers to spend will, at the very least, cause some hiccups to the economic recovery if not an outright stumble at some point.

But Bernanke and company will need to place a greater emphasis on the need to preserve price stability now that the worst is behind us. In order to keep a lid on interest rates, particularly long-term rates, markets must be convinced that the Fed is willing to eventually put muscle behind that rhetoric and not cave to political interests. While under the purview of the Federal Reserve and not the rate-setting FOMC, the Fed will continue backing away from liquidity programs that have been used to prop up the economy and resuscitate credit markets.

A more immediate concern is whether the Fed will sunset or extend their purchases of Treasury securities set to expire in September. It is debatable as to whether these purchases have helped bring down long-term interest rates, but they have certainly kept them from rising. The Fed's decision to extend the program or not has implications for mortgage rates either way. If the Fed extends the Treasury purchase program beyond September, it will help keep a lid on mortgage and other long-term interest rates, or at least keep them from climbing as fast as they otherwise would as the economy reflates. But it will also fuel concerns that the Fed is either stoking inflation by continuing to pump money into the system or that they are monetizing the U.S. budget deficit.

Failure to extend the Treasury purchase program at a time when the economy is regaining its footing and the Treasury continues to issue boatloads of new supply means there is little to restrain an upward march in rates. History has shown that interest rates go through spurts, moving a lot in a very short period of time and very little over longer periods of time. After kissing 4 percent in early June, the 10-year Treasury note has spent much of the summer in the 3.5 percent to 3.75 percent range, despite steady economic progress. If the Fed suddenly exits the Treasury market, we could quickly find ourselves playing in the 4 percent to 4.25 percent sandbox, putting 30-year fixed mortgage rates over the 6 percent mark. Still low in a historical context, yes, but enough to throw cold water on refinancing activity and perhaps even quashing some prospective homebuyers' plans as well.

Let's also look out into 2010. This year, the Mortgage Bankers Association forecasts $2 trillion in mortgage originations, and the Fed is buying $1.25 trillion of that. Will the Fed continue to buy agency mortgage-backed securities in large quantities after the end of the year? And if not, is there enough demand to soak up whatever the Fed doesn't buy? The Fed will need to carefully calculate in order to keep mortgage rates below 6 percent.

While we're still some time away from an increase in short-term interest rates, the Fed's game plan must take form and be verbalized now in order to keep interest rates from climbing too fast and to quell concerns about eventual inflation.

Wednesday, July 22
Posted 11 a.m. Eastern

Another jobless recovery?

Fed Chairman Ben Bernanke's appearance before the House Financial Services Committee yesterday lacked any unexpected revelations. One point in his prepared remarks did catch my attention, however.

"Although the unemployment rate is projected to peak at the end of this year, the projected declines in 2010 and 2011 would still leave unemployment well above FOMC participants' views of the longer-run sustainable rate."

Reading between the lines, Bernanke seems to suggest we're in for another jobless recovery. My own opinion is that it will be the mother of all jobless recoveries. Sure hope I'm wrong.

Regarding the economy: On July 31, the initial estimate of second quarter economic output, affectionately known as Gross Domestic Product, or GDP, will be released. There is a possibility that the economy, either based on initial estimates or subsequent revisions, will eke out some growth.

Now, let's not get too far out over our skis but be cautious about interpreting this if it should come to pass. Here's why: Any growth posted by the U.S. economy will largely be due to a shrinking trade deficit, as imports (what we buy) have fallen much faster than exports (what we sell). So bottom line, any growth in the U.S. economy during the second quarter is more testament to the resilience of foreign consumers than it is American consumers.

Reader comments: Here are a couple reader replies to my last post suggesting some much-needed improvements to the Making Home Affordable mortgage plan.

"I would like to write a comment about your proposal to let homeowners who lost their jobs not to pay their mortgage for number of months and then get reduced payments if their new income is lower. I think it's nonsense.

"If something like that should happen, I would like to see all the renters get similar provisions. And reduced rents as well once the income gets lower."

Landlords are in a position to make those concessions if they choose and if their own financial circumstances allow. I know of some that have suspended rent payments while their tenants are out of work.

"Your thoughts on highlighting the need to increase the refinancing eligibility caps to at least 150% addresses a vast amount of responsible homeowners who would benefit from refinancing to more affordable home loans. Speaking from experience, my home is over 50% upside down on the mortgage balance to home value ratio. I agree that this approach is effective, it is not another bailout, but a guarantee for the creditworthy on good standing loans that are on the books of government entities of 'Fannie' and 'Freddie'."

There are some others I hope to post in an upcoming blog entry. Stay tuned.

Thursday, July 16
Posted 2 p.m. Eastern

Are mortgage modifications really the key?

Not to beat a dead horse, but it is worth revisiting the Making Home Affordable initiative because the foreclosure problem just isn't going to go away. I want to point out two things: one that is missing and another that isn't working anywhere close to expectations.

Unlike 2007 and 2008, the primary catalyst for foreclosures is now job losses. This will continue to be the case through 2009, and, in my estimation, 2010 as well. One aspect of Making Home Affordable that is sorely missing is what I would term a "national forbearance program for the unemployed." You don't need me to tell you that unemployment is at a 26-year high with the number of unemployed having doubled since the onset of the recession in December 2007 to 14.7 million. Even scarier is that one-in-three, or 4.4 million, have been unemployed longer than six months.

So we can see that foreclosures aren't going to come to a screeching halt as long as we're seeing numbers like this. Which is why I feel that a formal "forbearance program for the unemployed" is a glaring omission from the plan and something sorely needed. Some may say that if homeowners had an adequate emergency savings fund to begin with that a job loss wouldn't lead to foreclosure. While I am a huge proponent of emergency savings, with 4.4 million people unemployed longer than six months, there are plenty of homeowners that DID have an adequate savings cushion only to completely blow through it during an extended period of joblessness.

So what would my so far mythical "forbearance program" entail? Only homeowners that could show they were current on their mortgage payments up until the point of a job loss would be eligible. These people are not deadbeats. They deserve the benefit of the doubt. And what I would like to see is a plan that relieves them of making mortgage payments during a period of joblessness. (And OK, maybe you limit it to a one-year time frame. I'm not going to quibble too much about the details at this point when we don't even have the current framework in place). Only once they return to full-time work would they be required to make mortgage payments. And if they go back to work at a reduced pay rate, they could be fast-tracked toward a potential loan modification at that point to bring the payments (but not the total debt owed) in line with their new income.

In addition, the current modification plan uses what is known as a net present value test to determine whether a modification makes sense. (This test assesses which of two courses has a higher current value and is done by discounting future payments back to a value today.) The net present value test is certainly applicable to a "forbearance program for the unemployed" and is one that eligible borrowers would likely pass with flying colors. After all, someone that has made payments on time every month while employed has demonstrated a willingness to make payments as long as they are capable. Forbearing mortgage payments at the onset of unemployment and resuming six or nine months hence would carry a higher net present value than the permanently reduced payments of a mortgage modification.

Again, I'd rather not quibble over the exact details and shades of gray of who is or isn't eligible. Rather, my goal is to point out a gaping hole that, if addressed, could slow foreclosures and avoid those that are preventable.

But instead, I continue to see a focus on mortgage modifications. Just recently, Treasury Secretary Timothy Geithner and HUD Secretary Shaun Donovan penned a letter to large mortgage servicers urging them to staff up and accelerate the pace of mortgage modifications. I'm not sure that cures our current ills. The Making Home Affordable Modification Plan is geared toward reducing mortgage payments as a percentage of household income, with the goal of preventing foreclosures by reducing mortgage payments to 31 percent of household income. For a variety of reasons, I am not a huge fan of the plan but there are some laudable elements.

However, with unemployment as the primary determinant of foreclosure, this does not work to fix the current problem. What's 31 percent of zero?

Some lenders have taken a step in this direction by reducing mortgage payments to $500 for those that are unemployed. This is nice, but without a job, making even reduced mortgage payments isn't feasible. There are priorities for the first $500 coming through the door that outrank the mortgage payment, such as putting food on the table, keeping the water and the lights on, and putting enough gas in the car to get to job interviews.

Now to my second point. The focus, or "push" if you will, on mortgage modifications is more unsettling if those same lenders and loan servicers forsake the mortgage refinancing side of the Making Home Affordable equation.

Clearly, the Making Home Affordable Refinancing program is not working anywhere close to expectations. Click here for Holden Lewis's fine explanation of the various impediments.

But make no mistake. The refinancing side of Making Home Affordable, or MHA, is critically important to avoiding a redux of 2007 and 2008. I'll go so far as to say that the MHA refinancing plan is far more important than the modification plan, even if the fruits of the MHA refi plan will not be truly evident until 2011 or 2012.

Here is what I mean: Folks, we've seen this movie before. Short-term interest rates are as low as they can go. Eventually -- whether led by inflation or an economic rebound -- the Fed will need to begin raising short-term interest rates. (This may be 18 to 24 months away, but we need to be thinking about it now). The one-year Treasury yield is currently 0.5 percent. It's not a stretch to see that eventually going back to 3 percent or 4 percent, and perhaps occurring rapidly when it does. When short-term interest rates move higher, that will spell higher monthly payments for millions of homeowners that have any type of adjustable rate mortgage. If they're stuck in an adjustable rate loan and are unable to sell because of being upside-down, look out! We don't want to go back to 2007 and 2008 just at the time when the economy is getting its feet back and the worst of the housing debacle would be behind us.

Fortunately, this is a bullet that can be dodged. But to do so means the MHA refi plan has to work, it has to work well, and it has to be expanded. Let me explain.

The MHA refi plan offers the possibility of refinancing millions of homeowners that are not currently in any financial distress into the permanent payment affordability of a fixed rate loan. These are homeowners that are in many cases, victims of nothing other than bad timing. Perhaps they bought a home in 2005 or 2006 only to see the value since plummet and not only wipe out whatever down payment they had but leave them upside down by a significant margin. Or maybe they bought a starter home in 2004 intending to move on by 2010 or 2011, and they took a 7/1 ARM. Now that their timetable has changed and the starter home is taking on a more permanent feel, they need a loan better suited to their extended time frame. In either instance, facilitating a refinance into today's low fixed rates avoids the possibility of future payment shock and keeps the homeowner in a home that they've demonstrated is affordable for their budget. (This is even a better option than the permanent mulligan of a taxpayer-funded mortgage modification for those that got upside down by using the home as an ATM.)

Sadly, there isn't much evidence that the focus of regulators, lenders and the administration is being placed on doing these refinancings. Instead, the focus seems to be kicking the can down the road through mortgage modifications that may or may not be necessary or effective.

Think about how many adjustable rate loans will reset between 2010-2012 and then add to that any adjustable rate loans currently outstanding that are experiencing payment decreases now only to be whiplashed upward in a higher rate environment. To make MHA refinancing viable and effective on the scale that it needs to be will require not only the focus of lenders and regulators but also the politicians. They can start by toning down the mortgage modification rhetoric and lifting the refinancing eligibility cap even further, from 125 percent to 150 percent or even 175 percent. This is money that is already on the books, owned or guaranteed by Fannie Mae and Freddie Mac. Refinancing and assuring stability in the payments involves no extra money being doled out, increases the likelihood that the borrower will remain current and avoids having to clean up another mess in a few years.

If you've read this far, you deserve to be heard. I welcome your thoughts.

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