Big Fed Move

Mortgage Rates Tumble

In a surprise, [The Federal Reserve] dramatically increased the amount of money it will create out of thin air to thaw out the still-frozen credit markets that have cramped lending to consumers and businesses alike.

Indeed, the immediate effect on the bond markets was striking, with prices rising and yields dropping sharply on the news. The yield on the 30-year Treasury bond, about 3.75 percent before the announcement, fell quickly to 3.4 percent and remained volatile. At the same time, the dollar plunged about 3 percent against other major currencies.

Edmund Andrews, "Fed to Buy $1 Trillion in Securities to Aid Economy"; The New York Times (3/18/09)

Today's big financial news was the Fed's decision to buy up to $1 trillion in bonds and mortgages. Mortgage rates reacted immediately; the sites I monitor showed a .25% drop, to 4 5/8%.

Guesstimates are that rates could fall another .25%, which would take them under 4.5%.

Not Your Father's Bankruptcy

What's So Bad About Bad Credit??

For many consumers, preserving one's credit rating is one of those sacrosanct, preserve-at-all-costs values.

But what if you don't plan to buy anything? Or are afraid to? Or simply can't afford to?

Then, a trashed credit rating really may not matter so much. Especially if it means ditching a whopper monthly mortgage payment on a house that has plunged in value.

In the new economic landscape that many Americans already inhabit, maintaining a high credit score is a luxury they literally can't afford. In fact, torpedoing one's credit by defaulting on a "legacy" mortgage may be quite rational, for five reasons:

One. Credit scores don't matter if there's no credit to be had.

When credit is flowing, good credit scores can open the vault doors. Now, however, those vault doors are slammed shut even for many good credit risks -- and there's nothing behind, them anyways. (At least not until Uncle Sam replenishes the banks' coffers.)

The "Pay-As-You-Go Economy"

At some point, even the profligate U.S. government is likely to find its own access to unlimited credit curtailed.

In his current letter to Berkshire Hathaway shareholders, Warren Buffett pronounces U.S. government debt the next big bubble, following in the wake of the Internet and housing bubbles.

Once that bubble pops, the government will discover what many consumers already know first-hand: it's increasingly a "pay-as-you-go" world.

Two. No one's buying anything. At least not big ticket items, anyways. And if you're not buying a big-ticket item . . . you don't need credit to finance it.

In many U.S. housing markets now, prospective Buyers have a adopted a "show me" attitude, triggering a vicious cycle: wary of being stung by falling values, Buyers are waiting for the market to clearly bottom, but while Buyers stay on the sidelines, housing prices inevitably fall more.

In the mean time, with more people renting instead of owning, fewer consumers need a good credit score to qualify for a mortgage.

Three. In the land of the bankrupt, the marginally solvent are . . . welcome.

Look around -- it's a recession. People's balance sheets have been hollowed out by falling home and stock prices, and now are being kneecapped by rising unemployment. Exactly who has pristine credit these days?

Beggars can't be choosers, and that's exactly what many retail companies catering to consumers are right now. If it's a choice between selling to marginal customers or not selling at all, many companies will choose the latter.

Four. Perversely, defaulting can increase borrowers' leverage.

Lenders receiving federal bailouts are under increasing pressure to "modify" (read, relax) mortgage terms for distressed borrowers.

How does a borrower signal financial distress? By not making their mortgage payments. Ironically, someone who's current on their mortgage is unlikely to get their lender's attention.

Five. Bad credit can be rehabilitated.

Credit scores aren't static, like college transcripts, but dynamic, like one's health. As consumers handle more credit more responsibly, their credit scores increase; if they miss payments or have multiple delinquencies, they decline.

Over time, most people's credit scores recover from a major default -- just like they recover from a major illness.

Given the epidemic number of foreclosures today, the federal government might logically take steps to shorten that recovery period.

Big -- and Little -- Ticket Purchases

Recession, Uncertainty Hammer Big-Ticket Purchases

What to know what's selling today? Not big-ticket items.

On a scale of 1-10 (1 is the lowest, 10 is the highest), here is a shorthand -- mine -- for the magnitude of various consumer (and business) purchase decisions. Just like the Richter scale, this scale is logarithmic, kind of (8.0 is a much bigger purchase than 6.0).

Anything ranked over 3.0 has seen a dramatic slowdown; anything over 6.0 has fallen off a cliff.

A. Consumers

Basic Necessities; "Sundries" (toothpaste, gallon of milk, candy bar): 1.0
First-run movie: 1.5
Nice Restaurant: 2.0
Tank of gas: 2.0
Clothes: 2.0 - 3.0
Appliances: 3.0 -4.0
Furniture: 3.0-5.0
Used car: 4.0-6.0
New car : 5.0 - 7.0
House: 10.0

B. Business

Capital equipment (commercial plane, agricultural combine, bulldozer): 10+
Publicly traded company (buyout): 10+++

To my armchair economist's eye, big-ticket purchases have been killed by: 1) economic uncertainty, including job (in)security; 2) financial pressure (and in some cases, hardship), caused by falling housing and stock prices, and rising unemployment; and 3) concern about falling asset prices.

Interestingly, any one of these can chill demand for houses: even people who are relatively flush and feeling confident about the future logically may hesitate to step up and buy if they're convinced housing prices have further to fall. That psychology explains why markets tend to overshoot (a phenomenon also associated with stocks): to coax people out of their defensiveness at market lows, bargains often have to become screaming bargains.

Of course, the companion to wanting to buy is being able to.

Fortunately, the federal government is increasingly focused on steps designed to address that. Those include: a fat tax credit to first-time home Buyers; very cheap mortgage money; and lots of fresh capital ploughed into Fannie Mae and Freddie Mac (which should then "irrigate" the housing market with added liquidity).

Will these steps work? Stay tuned. . .

Money's Fungible . . Borrowers Aren't

One Size, er, Rate Doesn't Fit All

One of the more noteworthy features of today's mortgage market, besides greater volatility and generally declining rates, is the wide range in quoted interest rates.

For sterling credit risks -- credit scores in the high seven hundred's or above, plenty of existing home equity (or a fat down payment, if buying new), stable jobs, etc. -- the gates of "(re)financing heaven" are very much open. If that's you, you can walk through and borrow at 30 year rates well below 5%.

However, if you don't meet those criteria -- and anywhere from half to two-thirds of all prospective borrowers/re-financers now don't -- Fuhgettaboutit.

It's also the case that people applying for jumbo loans are being quoted substantially higher rates than for so-called conforming loans (generally, under $417,000), because the latter can still be re-sold on the secondary market, while the former can't.

What that means for consumers is that there isn't one prevailing interest rate anymore -- they're dozens, depending on your profile and borrowing needs.

Amongst other things, that makes using the Internet and shopping for rates a little more daunting now. It also makes good lending relationships more valuable.

That's because, while money may be a commodity ("fungible") . . . prospective borrowers are unique.

Refinancing Motives

Refinance to Lower Payments --
or Avoid Higher Ones

With long-term mortgage rates flirting with 5% again, many homeowners should revisit whether it makes sense to refinance.

Refinancing (assuming you can) is appropriate in two situations: 1) you're able to substantially lower your monthly payments; or 2) if you don't refinance, you face the prospect of substantially higher monthly payments. It's also relevant whether you're planning on staying put or not: there's no point in paying to upgrade a mortgage that you're not going to keep.

Ultimately, the decision to refinance is just a cost-benefit analysis.

The cost is the 2.5%-3% or so you can expect to pay for the new loan (unfortunately, about the same cost as the original, purchase money mortgage).

The benefit is the reduced monthly payment.

To use concrete numbers, if you currently owe $250k on a 30 year, 6.25% mortgage, you could reduce your monthly payments about $200 by refinancing at 5%. If the cost to refinance was $6,500, you'd recoup the fees in a little less than 3 years. Over the life of the loan, your savings would total an impressive $72k! (You'd have to partially offset that by what you'd have if you'd instead invested $6,500 for 30 years).

My mastery of hurdle rates, internal rates of return, etc. was never that good -- and is nonexistent now -- but intuitively that seems like an attractive proposition.

Even if you can't improve your situation, you may want to refinance to prevent it from getting worse. That's the case if your current mortgage is set to adjust to a substantially higher rate soon, is non-amortizing (interest only), or negatively amortizing (the amount you owe actually increases).

In any case, to qualify for refinancing at all, your credit scores must be decent (mid-600's or better), and you must have sufficient equity to serve as collateral. Unfortunately, that disqualifies many homeowners who bought in the last couple years with little or nothing down, and have seen their homes drop in value.

If you're a bona fide refinancing candidate, here are three tips: 1) be sure to ask for the federally-mandated disclosures (the Truth-in-Lending, or "TIL," and the Good Faith Estimate; 2) inquire about a re-lock option, which lets you capture a lower rate if they drop while your application is pending; and 3) shop around.

Money is fungible, and quoted fees vary. Think of it this way: before you spent $6,500 on a used car, new roof, etc., you'd expect to do some due diligence, wouldn't you?

Short Sale Hurdles

Pursuing a Short Sale?
Better Be Patient

One of the reasons that a "short sale" can be so protracted is all the decision makers involved.

For those who aren't familiar, a short sale is when a listed home is worth less than the mortgage against it. Rather than foreclose, the lender can often do better, i.e., lose less money, by agreeing to instead reduce the mortgage balance it is owed.

Make that lenders, plural.

The flip side of the securitization phenomenon, by which millions of individual loans got bundled and sold to investors worldwide, is the logistical nightmare that results when housing prices tank.

Before securitization, a short sale required one lender to sign off. Now, that number can easily be 15 or 20 . . .