"Bailout" Passes. What's Next?

October 3, 2008 -- After an initial and shocking failure, elected representatives spent most of the week scurrying to come up with a "better" version of Treasury Secretary Paulson's plan to use up to $700 billion in taxpayer funds to buy up bad mortgage and financial assets. In the end, the tab could run as high as $810 billion, with hopes that some of the assets can be resold back into the market for a profit. Of course, this assumes there will still be a market for them -- or any market at all -- when it's time to sell them.

It's believed that with such a plan in place, credit spigots will begin to crack open to a greater degree, and perhaps they might. There's no certainty there, either. Investors may simply shed bad assets in exchange for cash, invest the money in 100% guaranteed Treasury obligations, and swear off any form of risks for the foreseeable future.

Ultimately, we think the bill will help, but any bill which grew from a two-page sketched proposal to 451 pages surely cost more than necessary and could contain any number of items which may cause unintended consequences. It will take some time to read and digest it.

That said, the question has been asked many times of us over the past two weeks: "What does it mean for mortgages?" Unfortunately, the short answer seems to be "Very little." In reality, mortgage markets are not really the focus of the bill; they've already been considerably supported, what with the Federal takeover of Fannie and Freddie and the expanded role for FHA. Those markets aren't going anywhere. Rather, the creeping malaise of credit markets has infected commercial lending, business credit, credit cards, auto financing and other areas of the economy. As those markets and audiences are now being starved for credit, the economy faces more serious peril.

With the "support plan" now in place, lenders and investors should begin clearing certain of the bad assets off their books. This will hopefully loosen up credit for all borrowers, not just mortgage shoppers. However, it is possible that private-market jumbo mortgage rates -- the old traditional, non-agency jumbos now supported primarily by portfolio lenders -- could have some space to fall once the book-clearing process begins. Those high-quality jumbos make nice investments with rates in the mid-sevens, and banks with fresh capital generated by shedding losing bets may push some more money out their doors to this audience. Still, those rates are likely to remain extraordinarily high (relative to their conforming counterparts) for some time to come.

For conforming loans, as soon as regulators can catch their breath, it does seem likely that at least some of the more recently imposed underwriting restrictions at Fannie, Freddie and even the FHA will come under scrutiny. This week, Fannie Mae dropped a planned increase for at least one of the fees instituted back when it was a private company and seeking to protect shareholders from losses; the Adverse Market Delivery Charge (AMDC), a quarter-point fee initiated in March, was slated to be doubled starting in November, but instead will remain at just a quarter-point. More reviews of underwriting criteria by the GSE's new stewards are certain to come as we roll forward. The massive housing rescue bill passed back in July -- remember that? -- is just starting to kick in, as well.

The nation's banking landscape continues to shift markedly. Just days after Washington Mutual was merged into Chase, Wachovia was placed under the care of Citibank... for about three days, when a deal was announced to sell the company to Wells Fargo. The lawsuits are sure to be raging after this move, but the FDIC is only seeking to protect its insurance fund (and ultimately, taxpayers) to the degree possible.

As far as the price of mortgage money goes, it's essentially been a "follow the bouncing ball" kind of period. Along with massive selloffs in equities and the resulting huge flight to quality runs to treasuries and cash, rates have pogo-sticked all week long.

HSH's overall indicator of the cost of mortgage money for all borrowers -- covering true conforming, private-market jumbo and new "expanded conforming" loans -- moved marginally higher. HSH's Fixed Rate Mortgage Indicator FRMI rose by just two basis points to 6.72%, while a companion 5/1 Hybrid ARM series mimicked that rise to finish the week at 6.58%. See the latest trending charts for these and other series. Conforming 30-year FRMs closed the week at an average 6.23%, up just a single tick.

Daily FRMI rates are available at http://www.hsh.com/. News outlets seeking daily statistics for conforming or jumbo mortgages should contact HSH for more information.

Increasing signs of economic stress are emerging everywhere you might look. It's uncertain how much damage the market swoons of the past week and a half have done, but it's a reasonable bet that there will be at least some lasting effect. While little of that would be reflected in the latest data, those effects should begin to show up in the coming weeks.

Looking back to some 'older' data from August, Construction Spending came in unchanged from July, overall. Spending on commercial projects dipped by 0.8% during the month, while public outlays nudged higher by a like amount. We do, however, see perhaps the first glimmer of hope for the moribund homebuilding market; spending for residential projects edged 0.3% higher during the month, the first such increase in 2008.

Factory Orders dropped sharply in August. The 4% decline was much more than expected, and easily erased the 0.7% lift in July. The corresponding measure of spending by businesses -- already weak and erratic -- slumped by 2.4%, in what seems to be a combination of worsening economy and lack of capital for finance purchases.

With that drop in orders, and probably also influenced by the marginally stronger dollar in recent weeks, the Institute of Supply Management survey of manufacturing activity nosedived, falling six full points to land at 43.5 for September. That drop puts the indicator of factory activity at a 2001 level. It may have been exacerbated due to effects from Hurricanes Gustav and Ike, and the on-going Boeing strike, and so may be overstated, but regardless, the factory sector is enduring increasingly difficult times. One bright spot: the measure of businesses reporting paying higher prices is on the wane, falling from June's 91.5 (indicating almost all respondents reporting higher costs) to September's 53.5, closer to neutral. Inflation pressures are backing off, lending some strength to calls for the Fed to again trim short-term interest rates.

However, the decline in factory activity appears to be uneven. A local report covering the New York region suggested continuing decline, but a Chicago-area review revealed just a slight slip in an otherwise healthy recent pattern for growth. Of course, it depends upon what sort of manufacturers are in the region. Those which serve the auto industry have been hit hard, suffering from the twofold whammy of a weak consumer and restrictive financing. Unsurprisingly, auto sales slumped in September to just 12.5 million (annualized), down from a rebounding 13.7m clip in August. The latest reading was the lowest rate since January of 1992, so the entire auto supply chain is taking it on the chin as the economy flounders.

The ISM's measure of non-factory activity was steady, holding in virtual standstill mode. The 50.2 reading for September was little changed from August's 50.6, and has been more or less treading water since February.

Personal Incomes moved 0.5% higher in August, besting expectations. While some of the influence was the extension of jobless claims, wages rose by 0.4%, the highest increase since March. Spending, though, remained flat, and the nation's rate of savings eased to 1%. The effect of the stimulus payments has come to an end, so any spending will need to come from income growth or at the expense of savings. However, the continual decline in gasoline prices should ease some burdens on pocketbooks, and foster some spending on other items, to the benefit of the larger economy.

Measures of consumer moods recently moved off lows, following the decline in gas prices, but the whipsawing markets may turn them darker again. For the third straight week, the ABC News/Washington Post poll of Consumer Comfort remained at -41, still quite bleak but at least steady. During September, the Conference Board's review of Consumer Confidence ticked up to a reading of 59.8, up from August's 56.9 level and exhibiting mild but steady improvement off June's lows.

If job markets continue to decline, such optimism may grow harder to find. Weekly unemployment claims rang in at a hurricane-goosed 497,000 for the week ending September 27, but regardless of the reason, new claims remain high. As well, while the loss of jobs during this downturn has been mild compared to historical patterns, it does seem to be deepening. In September, the economy shed 159,000 jobs, the ninth consecutive month of job losses, now nearly at an accumulated 750,000 since the turn of the year. The nation's unemployment rate remained at 6.1% for the month, but given the gyrations in financial circles over the past four weeks, and other markets so dependent upon them, more layoffs seem destined to come.

Now that we've got a "rescue" or "support" plan in place -- please don't call it a "bailout" -- where do we go from here? Financial conditions should be improving, at least slightly, in the weeks ahead; inflation seems to be waning, at least for the moment, and markets have been flooded with liquidity, not that it's making it out to main street just yet. We're hopefully that it will; in these times of unprecedented government moves to kick-start markets, it's no longer too far-fetched to think that more aggressive and direct government moves into other areas of lending can't occur, if the banks remain unwilling or unable to do it. More likely, pressure will be exerted to get things moving, even if rates don't fall right away. We'll see where that goes.

A break from turmoil next week? Don't bet on it. To be kind, markets remain jittery, risks abound in this economy, and we'll get little significant new economic data to crunch, leaving plenty of time for worrying to fester. We will, however, get a look at the minutes of the last Fed meeting, so that might be instructive.

Rates? We keep hoping for stability. This week, we did find that, and there could be a little improvement next week, perhaps a couple basis points at best.

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