Mortgage Rates Down, For Now

December 7, 2007 -- Home mortgage rates managed a decline this week, with the average 30-year fixed rate mortgage (FRM) shedding eleven basis points (0.11%) to land at 6.38%, according to the nation's widest scan of mortgage prices. Five-one hybrid ARMs lost eight basis points, closing the survey week at 6.17%.

Despite the fall in rates, the disparity between conforming and jumbo mortgage prices widened again this week, as conforming loans landed just below 6% while jumbos hold in the upper sixes. After narrowing through mid-November, the differental between those products has again ballooned and is nearing the extraordinarily wide gaps seen during the summer's credit market crisis.

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The week also saw the unveiling of a controversial plan to help at least some borrowers with subprime mortgages. Dubbed 'Hope Now,' the industry-backed plan -- which, its backers stressed, will not involve the use of taxpayer dollars -- set out a series of criteria for those who would be helped.

Borrowers who have certain subprime products, are current in their payments, meet a FICO score test, have little equity in their homes, and face an interest rate reset in the coming two years may be eligible to have their loan's interest rate fixed at its present level for five years. As many as 600,000 homeowners facing default could be eligible. Servicers will begin combing through their books to find candidates, who, under the plan, may see their loan rate fixed even if the servicer cannot get in direct touch with them.

The process of fixing the interest rate for a time appears to be consistent with the kinds of loan modifications already being offered by some servicers, but on a much larger scale. Of course, there are concerns about lawsuits from investors forced to take a "haircut" in terms of return, and we'll need to see what develops on that front, as well as the ultimate effect on investor demand for certain kinds of home mortgages in the future.

This group of borrowers is also those most likely to be able to refinance into an FHASecure loan; it's our guess that the freezing of the interest rate is a way to buy time for those borrowers to get out of their subprime loans entirely.

Borrowers failing to meet the "streamline" criteria may still be eligible for a response, but it's unclear how many of the remaining group -- those already failing in their loans, or those who are managing to make higher monthly payments -- will be offered new or better deals. It's a safe bet that there is more pain yet to come for the nation's housing and mortgage markets as more loans continue to head into foreclosure.

Failure rates for mortgages continue to rise, according to the Mortgage Bankers Association, which reported that 5.59% of all first mortgage loans outstanding have moved to delinquent status. That's the highest percentage of loans in arrears since 1986. Loans of all kinds are failing at an increased rate, but the increases are led by subprime ARMs. Overall, good-quality "prime" loans are failing at a 3.12% rate while subprime loans are failing at a 14.82% clip. FHA loans, it should be noted, are failing at a near 13% rate, and moving more former "subprime" borrowers into FHA may tend to push that number higher over time. Of homes already in foreclosure, a subprime ARM was the financing instrument in 43% of the cases; however, it's interesting to note that prime loans of all stripes make up 36% of the loans in foreclosure, compared to 55% of subprime product (versus about 9% for VA and FHA-backed instruments).

It's not clear from the MBA's release whether the "prime" loans which are failing have certain risky characteristics associated with them, such as no income documentation, high debt-to-income (DTI) ratios, or high LTV ratios (i.e. piggybacks). Regardless, the news isn't especially good.

Although the nation's housing and mortgage markets continue to face challenges, there are still few signs so far that those troubles have infected the economy as a whole. Consumer spending seems to be holding up; sales for new cars and trucks rose to a 16.2 million (annualized) pace during November, and retailers have noted fair increases in November sales (though perhaps at the expense of December sales, as Thanksgiving was 'early' this year). Borrowing by consumers rose by some $4.7 billion in October, led by new charges to revolving (mostly credit card) accounts. Installment borrowing, often used for things like furniture, did however fall back during the month.

Spending and borrowing will continue to pace higher provided that folks continue to have jobs. The number of new applications for unemployment benefits eased back to 338,000 during the week of December 1, perhaps a clearer reading after a Thanksgiving-distorted one last week.

Fewer layoffs are of course welcomed during the holiday season, as are new jobs being made available to those who want them. During November, a new 94,000 hires occurred, a mellow-but-solid number given that the unemployment rate continues to hold at 4.7%. Hiring remains in a muted pattern, but importantly, a rising one. Fears that the economy is slipping toward a recession are partly allayed by an expanding job market, and the 94,000 number is about average for the past six months. Average hourly earnings rose by 0.5%, the fastest monthly rate since June.

At other times, this may have sparked concerns about the formation of wage-led inflation, but not when weighed against the latest report covering worker output. Productivity rose at a stout 6.3% in the third quarter of 2007, above even optimistic forecasts. The ability of workers to produce more goods in the same amount of time means that they can be paid more without any undue effect on final prices. Relative to other components, the cost of labor to make a given widget declined by 2% during the quarter, helping increase worker pay and business profitability during the quarter.

That's good news for those hoping to see the Fed cut interest rates again when it meets next week. Oil has recently retreated from near $100 per barrel, which should help mute price pressures somewhat; the 'core' measure of prices remains fairly tame, too, so the Fed will have more leeway to cut short-term interest rates on December 11 if it wishes. Speculation that a half-point cut might be on the table was diminished late this week and especially after the employment report, as an economy which isn't flagging badly probably doesn't need cheaper credit all at once. A quarter-point cut is more likely, but there is still a chance for a broader stroke, especially since inflation seems manageable at the moment.

Some boost from lower input costs would help foster profitability at banks and others dinged by the ongoing financial fallout. As well, it could serve to goose manufacturing somewhat, which appears to need a little kicker at the moment. According to the Institute for Supply Management, their measure of business activity for manufacturers remained just over the breakeven point in November. The 50.8 reading was down just a tick from October's 50.9, but either number qualifies as "just hanging on" at the moment as numbers below 50 indicate contraction. As well, there was a slowdown noted in the ISM's 'non-manufacturing' (aka service) industry index, which decelerated from 55.8 in October to 54.1 in November. The "prices paid" subindex show that both groups did note increasing costs, too.

Back in October, Factory Orders managed a 0.5% rise, but the business spending component -- those dollars outside of military and aircraft spending -- fell back by a full 2%. October was obviously a weak month, and the ISM readings for November don't suggest a measurable increase in business outlays, so we'll need to wait to see if business spending has revived.

What hasn't revived are consumer moods, which are truly dark as we move into the holiday season. The University of Michigan survey's preliminary December reading was the lowest since Hurricane Katrina blew away the Gulf Coast, and the second lowest since the early 1990s. The ABC News/Washington Post weekly poll slumped back to -24, easily the lowest this year and comparable to levels seen back in 2003. So far, darkening moods haven't dented consumer spending greatly, but it does seem possible that some retrenchment may come once the holidays have passed.

As noted, the Fed meets next week to discuss all of these issues, and more. The 10-year Treasury (a reasonable influence for at least conforming 30-year FRMs) was in the mid-3.80% range for part of the week but shot up to over 4.10% by late Friday. News that the economy isn't failing faster, and that some of the fixable mortgage problem may be fixed, helped those rates to rise, and it's a reasonable bet that this week's fall in rates (mostly in conforming product) will reverse next week, too. Most likely, the overall average will edge up a couple of basis points.

One additional item this week: It should be noted that borrowers who have one-year Treasury-based ARMs will see very favorable adjusted interest rates coming their way. The present index value of 3.25% plus a typical margin of 275 basis points adds up to a new interest rate of just 6%. However, LIBOR-based ARMs are likely to jump as much as a percentage point above that, as those instruments continue to suffer from troubles abroad.

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