How Is Unemployment Calculated?
Here in the US, the unemployment rate is estimated by a household survey called the Current Population Survey, conducted monthly by the Federal Bureau of Labor Statistics. The unemployment rate is calculated by dividing the number of unemployed persons by the size of the workforce. An unemployed person is defined as a person not employed but actively seeking work. The size of the workforce is defined as those employed plus those unemployed.

Largest Employer In U.S.
Who is the largest private employer in the United States? Wal-Mart! 2.1 million of us work there. In the public sector, the US Government employs about 2% of the nation’s workforce. The US Postal Service is the largest civilian employer, with about 600,000 folks. Private sector job growth continues to be the key to a sustainable economic recovery, especially if we expect to see much of an improvement in housing prices. Economists continue to believe the probability of a double-dip recession remains low, but are cautious. Heading into this employment data, most believe that if private sector job creation does not improve (or at least hold-up) in the near term, there will be significant ramifications on the economic horizon ranging from the outcome of the November mid-term elections to the likelihood that the Fed proceeds with an additional dose of quantitative easing.

Jobs Report Summary
The long-awaited payroll numbers came out, and Private payrolls rose 67,000 in August after a 107,000 increase in July. The unemployment rate rose to 9.6% from 9.5%, but it was a “good” rise in the unemployment rate since the participation rate rose to 64.7% from 64.6% and household employment rose by 290,000, the first increase in four months. Average hourly earnings were +0.3% month over month, better than consensus expectations. Although it is not a great number in the big picture, but it was better than expected. As you’d expect, the bond market had a bearish reaction, with 10-yr Treasury prices losing a point and moving up to a yield of 2.74%. Mortgage prices are worse between .250-.50. Look for things to become quiet and thinly traded as folks head out for the holiday weekend. Click Jobs Report tag below for full commentary and charts on today’s jobs report.

Mortgage Rates vs. Mortgage Bond Prices
Everyone knows that the prices reflected in the security market for mortgages are not being passed through to rate sheets. (If a Fannie 4% is trading at 103, plus a servicing-released premium, why isn’t a 4.5% loan priced at a 3 or 4 point rebate on the rate sheets?) Rate-sheet prices, however, are beginning to improve a little, relative to MBS prices, an indication that originators are possibly creating some capacity and attempting to grab some refi production volume. It isn’t 2002-2003 yet, for many reasons, but the mortgage market has a long history of “warming” when rates stay low for an extended period, finding ways to increase refi volume over time.

Pending Home Sales
Yesterday the markets were relatively quiet. Most of the price volatility happened in the early morning. The 10yr rallied off 4.00% early April to make new rate lows last week 2.42%. That’s a monster move by any measuring stick. Mortgages wound up Thursday down (worse) between .125-.250 with origination running at about $3 billion. Stocks rallied modestly, while the 10-year Treasury note worsened by almost .5 and its yield hit 2.63%. The Pending Home Sales Index for July rose 5.2% to 79.4 versus an expectation for a 1.1% decline – somewhat encouraging but no one is expecting a big upswing in prices.

No More MBS Buying From Fed
Rates continue to trend lower, helped yesterday by the release of the FOMC meeting’s minutes which alluded to the possibility of the Fed reinvesting in MBS’s. (But heck, as one trader told me, low mortgage rates are helping agency-qualified borrowers, not others in the economy like renters who can’t qualify, not those that don’t have jobs or those that simply pay cash for houses.) “A few members worried that reinvesting principal from agency debt and MBS in Treasury securities could send an inappropriate signal to investors about the Committee’s readiness to resume large-scale asset purchases,” the Fed said in the report, referring to mortgage-backed securities. The minutes from the August 10 meeting made it clear that the Fed is far from ready to restart Quantitative Easing Round 2.

FDIC Banks Report $22b Aggregate Profit
“It’s hard to make a comeback when you haven’t been anywhere.” Conversely, banks have certainly made a comeback: FDIC-insured institutions reported an aggregate profit of almost $22 billion in the second quarter of 2010, a $26 billion improvement from the $4 billion net loss the industry posted in the second quarter of 2009. This is the highest quarterly earnings total since the third quarter of 2007. Earnings remain low, however; the primary factor contributing to the year-over-year improvement in quarterly earnings was a reduction in provisions for loan losses.

Commercial Real Estate Update
“Commercial real estate markets showed surprising resiliency during the second quarter, with property transactions rising solidly and leasing activity holding up better than expected. We remain cautious in our outlook for commercial real estate and construction.” So states Wells Fargo’s economics department. “The rise in delinquency rates in recent years was mostly caused by the sharp contraction in employment, retail sales and the rate of household formation growth. The apparent improvement in demand may be overstated, as many firms are taking advantage of soft market conditions to upgrade space and locations. The larger immediate issues with commercial real estate continue to be the overhang of commercial real estate loans coming due over the next few years and the large number of development projects that have been partially completed or less, which continue to weigh on community bank portfolios. After showing some resiliency earlier this year, commercial real estate prices fell sharply in June.”

Mortgage Apps Up, ADP Employment Down
Today we’ve already had the MBA’s application index (apps were up 2.7% last week, with refi’s up 2.8% and purchases up 1.8%), and the ADP numbers which were down 10,000 but notoriously questionable about predicting overall employment data (the ADP # does not include government hiring).

In July Fannie Mae issued over $42 billion in new mortgage backed securities, up 6.4% from June, and the highest level of MBS issuance since February. Freddie, however, dropped slightly from June to July at about $26 billion, possibly due to a drop in the purchase of refi’s. Fannie reported that the serious delinquency rate (90 days or later) on its guaranteed single-family mortgages was down for the 4th month in a row, and fell below 5% for the first time since October 2009. Freddie’s serious delinquency rate on its guaranteed single-family mortgages fell once again, remaining below 4% for the second consecutive month.

Why Banks Aren’t Lending More
Why aren’t large depository banks loosening their credit guidelines and lending more money? Market watchers suggest that one reason is the buy-back issue: FNMA & FHLMC have sizable losses on bad loans and are considering forcing eleven large lenders (the biggest being BofA and Chase) to buy back loans which would result in losses of over $100 billion. Not only are banks grappling with that potential issue, but there may also be a lack of confidence in the health of our economy banks, businesses, and consumers. No one wants to borrow money to buy a house or expand their business if they aren’t confident about their job or more optimistic about the economy. And right now, as there often is, investors can’t seem to decide if the bond market (which is pointing toward further weakness) or the stock market (pointing toward stability and moderate growth) is more correct about predicting the future health of the US economy.

Is There A Bond Bubble & Are Rates Set To Spike?
Rates have an inverse relationship with fixed-income prices, meaning that when bond prices go up, rates go down. With the major drop in rates in the last several months comes talk of a “bond market bubble”. Most economists do not feel that we’re in a bond market bubble where there is a disconnect between prices and fundamental reality, but it is still worth talking about. All bubbles follow a common pattern, whether it concerns high-tech stocks, tulip bulbs, or real estate. Initially prices increase when a new opportunity presents itself with the prospect of good returns. Investors become more optimistic and lenders become less risk-averse. Suddenly everyone is chasing prices regardless of fundamental values, expectations become unrealistic, and speculators who are more concerned with short term gains rather than long term returns flood the market. But clearer minds begin to prevail, and insiders start to sell. Asset prices stop rising, panic sets in, and investors rush to unload positions before the next guy, and prices crash.

In the current case of fixed-income securities, however, fixed-income instruments like Treasuries are not new. There have been good returns, but any excitement is certainly tempered by the fact that the federal government will record a $1.3 trillion budget deficit in 2010, with fiscal year 2010 (ending 9/30) seeing Treasury debt issuance of about $2.3 trillion of which net issuance is about $1.7 trillion. At this point it appears that investors are buying bonds out of fear and from being defensive rather than being excited about bond prices rallying and rates dropping. And as we all know, there is little in the way of credit truly expanding – banks are holding onto their capital. Cash continues to be king – maybe the Fed should charge banks for holding onto capital.

Rates Not As Low As Mortgage Bonds Would Suggest
Let’s turn our focus to securities and pipeline hedging for a moment. What’s the scoop on 3.5% securities becoming more active? After all, the 4% coupon (which contains, basically, 4.25-4.625% mortgages) is trading around 103. 3.5% securities are near par. And when you throw some servicing value on there, whether it is .5 point or 1.5 points, it should present a rebate on the rate sheet for 30-yr mortgages around 4%. But this is not being reflected on the rate sheets, and the production is not there yet enough to calm fears of non-delivery issues. Volume in 3.5% securities has been steadily creeping up, and becoming more liquid, but seller’s are still timid of any kind of “short squeeze” if they sell 3.5′s out in November or December, and then rates slide up and they don’t have the production. On top of that, production is still in the mid-4′s, which goes into a 4% security. When profit margins start dropping a little, 3.5% volume should increase.

Who’s Profiting From Troubled Loans
Under the heading, “The more things change, the more they stay the same”, investment banks and “vulture funds” are garnering headlines for securitizing and selling troubled loans. The good news, of course, is that it helps keep the talk of a private mortgage bond market alive, and give servicers an outlet for their bad loans. The bad news, if you want to call it that, is that the pools are made up of delinquent loans rather than original liens. One can expect to see more news about companies with names like Penny Mac, Kondaur Capital, Allonhill, Residential Credit Solutions, Arch Bay Capital, Carrington Mortgage, Equifin Capital, etc., and probably ratings provided by the usual Fitch, Standard & Poors, and Moody’s. The process is more conservative this time around (although I don’t know precise details), with supposedly issuers having to set aside half or more of their assets as a cushion from loss, while the cash flow goes to the investors.

Market Update
Thursday started off somewhat quietly, but by the end of the day mortgage securities filled with rate sheet current coupon mortgages were better in price by .375. Just as there were numerous prices changes for the worse on Wednesday, the MBS market got it all back Thursday – woe to anyone who locked Wednesday instead of Thursday. And not only did all rates drop, but mortgages “tightened”, meaning they improved more than Treasury securities did. The $29 billion 7-yr auction went well (coming in at less than 2%!) at the same time that the stock market began to falter. Soon traders saw that investors interested in buying mortgages outnumbered sellers, with only $1.3 billion being sold.

Huge economic day today, and so far mortgage bonds are selling off, pushing rates higher.

What If All Mortgages Were 1% Lower?
A Wall Street acquaintance of mine wrote to me about dropping trillions of dollars of mortgages by 1%. “I think that something like it may just happen. Many people I’ve talked to have said the same thing: ‘The money would go directly to the borrowers to help our economy, and totally bypass our government. There would be no claims of the government wasting the money on projects or programs at the taxpayer’s expense.’”

TARP Taxpayer Cost Continues To Drop
The government’s $700 billion bailout of the financial system (TARP) will be argued about well into the future, but the cost to the taxpayer for TARP continues to drop. The Congressional Budget Office projected that the overall deficit impact of the TARP will be about $66 billion, down from the $109 billion estimate the Congressional Budget Office made earlier in the year, and a significant drop from the initial projection of $350 billion. TARP, as we all recall (or maybe not) gave the government the authority to use $700 billion to prevent the collapse of the financial industry (and a few automakers along the way). Banks are repaying bailout money and automakers are continuing to payback their loans.

S&L Loan Volume Up
According to the OTS, the 753 federally chartered savings and loans, also known as thrifts, originated more single-family loans in the 2nd quarter (about $31 billion, or about $500 million per day) than in the 1st quarter. These thrifts sold $28 billion in single-family loans in the second quarter, up slightly from the first quarter, but down from the $60+ billion they did a year ago.

Loans Getting Harder For Property Flips
There’s growing sentiment among lenders that property flips—buying a home that was previously foreclosed on at a discount, doing some small cosmetic touch ups, and quickly selling it for more—may represent an unacceptable risk. For example, flips create quick and substantial profits for the property sellers, but potentially high losses for the investor, and the properties are typically located in areas with a high percentage of distress sales. Investors believe that second home occupancy is often dubious, and borrowers who purchase investment properties out of flip transactions are often gullible, inexperienced in property management and unfamiliar with the area where they are buying. The projected rental income may not be realistic because of an imbalance between rental properties and available tenants, or borrowers may be attracted by supposed guaranteed rental income not disclosed to the lender – which is unacceptable. There is a high potential for severe property abuse by foreclosed borrowers, vandals or squatters, and some properties purchased from institutional sellers do not include interior inspections that would discover plumbing or electrical problems. And often times any renovation is merely cosmetic.

Record Low Existing Home Sales
On to the markets. Tuesday bonds rallied and stocks got whacked with a huge drop in Existing Home Sales. Yesterday we learned that New Home Sales fell over 12% to the lowest levels since 1963 and giving us 9 months’ worth of inventory at current sales levels. Initially we saw the same reaction as we did on Tuesday, with prices improving and stocks selling off. The 10-yr Treasury moved into the low 2.40% range. But then the psychology changed, for no particular reason other than “we’ve come a long way, and nothing goes up or down forever – the markets are over-extended”. The 5-yr Treasury note auction came with a coupon of 1.25%, and 5 years is a lengthy amount of time to tie up your money and “only” earn 1.37% the entire time. Are things really that bad here, and expected to be that bad for 5 years, in the US? Mortgages went from better by .375 in price to roughly unchanged, which resulted in rate changes from investors zipping around e-mails like flying monkeys.

Today’s Market Activity
This morning we had the weekly Initial Jobless Claims number, and $29 billion 7-yr note auction. Claims were 473,000 from a revised 504,000 – a drop of 31,000. Treasuries sold off slightly, nudging rates higher. We need to see evidence in next week’s August employment report that the labor market continues to expand, even if only modestly. This morning’s number not a particularly great number, but stocks like it because it is not a terrible number. After it we find the 10-yr up at 2.54% and mortgages worse between .125 and .250.

Guns & Mortgages
This story speaks for itself, here’s the link and the epic lead paragraph below: Prosecutors: Mortgage Worker Got Drunk, Shot Computer Server

A Salt Lake City mortgage company employee allegedly got drunk, opened fired on his firm’s computer server with a .45-caliber automatic, and then told police someone had stolen his gun and caused the damage.

Effective Rate of All Mortgages is 6%
Jefferies, and other Wall Street firm’s analysts, have recently pointed out that the effective rate of interest on all US mortgage debt outstanding (about $11 trillion – more than US Treasury and corporate debt combined) has barely budged in recent years at just over 6%. Like a kid looking through the window at candy, originators know this, and that the overwhelming number of households, on average, are paying the same rate they have for quite some time, and funding conditions “for the largest and most important part of the US economy – the consumer sector – continue to be bad. And if a borrower can’t refinance, and lower their monthly payment, they tend to hunker down and put the money into savings – which often time is invested by banks into Treasuries. And of course this serves to push rates down even more.

Analysts believe that if overall rates drop by 1% for all borrowers, it may translate into potential annual savings of more than $30 billion in lower monthly payments. (No, I didn’t run the numbers myself.) This transfer would shift money away from investors and money managers and into the pockets of borrowers – the fabled consumer sector, which has been lagging. And it follows that this desperately needed money would help stimulate the economy, right? But as we all know, origination capacity remains a bottleneck either through regulation or through lack of equity/credit. Investors would probably rather have their holdings of 6% (on average) mortgages ratchet down to 5% then go to 4%. And so the conjecture about a massive government-led refi wave continues.

Government Loan Modifications Struggling
But few people, if any, who follow mortgage statistics are arguing that any of the government’s modification plans are working. In fact, few, if any, of the people with whom I have spoken who are actually in the front lines doing the modifications say that it is going well. Even the US Treasury, in its latest report on 17-month old HAMP, noted that “the percentage of homeowners dropping out of the Obama administration’s premier housing rescue program rose in July to nearly half of participants, as owners receiving aid continued to struggle with documenting their eligibility.” According to the Treasury Department, about 48% of the 1.3 million homeowners who started a mortgage modification through July have dropped out, up from the 41% noted in June. Modification trials offered in the program prior to June 1 did not require up-front documentation of income or eligibility, and many trials are now being canceled. As a result, Treasury said 100,114 participants dropped out of the program in July — more than four times the 24,577 new modification trials started. Overall, the Treasury said HAMP has lowered payments for a total of 1.3 million homeowners that received trial modifications since the program was launched.

Wells Ramping Up CMBS Team
In a story out of Bloomberg Businessweek, Wells Fargo & Co. is plunging back into the commercial mortgage-backed securities market by adding more than 20 bankers and support personnel during the past three months to increase loan originations and bundle them into CMBS. (I sure hope that they know what they’re doing, since every time I drive by a shopping center or office building I see plenty of “for rent” signs.) Wachovia, now owned by Wells, was the #1 underwriter of CMBS’s from 2005 to 2007, and then had over $2 billion in losses in 2007 and 2008. As we know, commercial property values have declined 39 percent from the 2007 peak, according to Moody’s Investors Service. The decline has made underwriting loans less risky, and banks can dictate more conservative terms and choose the most creditworthy borrowers.

Record Low Existing Home Sales
The stock and bond markets were somewhat quiet yesterday until NAR’s Existing Home Sales number “hit the tape”, plunging 27.2% to sales’ lowest levels since 1995 and setting a new record low for this series which goes back to 1999. In addition, the data was revised to show a bigger drop of 7.1% in June, which was the last month that homebuyers were able to receive the homebuyer tax credit, and pushes out the housing inventory to over a year. The national median home price rose 0.7 percent from July last year to $182,600, but why build a new house when there is a year’s inventory at current sales rates, and the huge overhang of foreclosures that are set to enter the market as re-sales over the next several years?

Market Reaction To Home Sales Data
As we saw, rates dropped and fixed-income prices improved. Two-year Treasury yields hit another record low, 10-year notes rose 29/32 to yield 2.50% from 2.60%, and mortgage securities were better by a solid .375 in price (some portion of which made its way onto rate sheets for originators). (Sometimes economists, when they are feeling their most dour, compare the US economy to Japan’s. As a point of reference, Japan’s 10-yr note first closed below 2.00% in the autumn of 1997, and since that time it’s averaged 1.48%) Reuters released a poll showing that 72% of Americans are “very concerned” about unemployment and more people now disapprove of President Barack Obama than approve of him – more evidence of a slowing economy and the consumer hunkering down.

Market Roundup
This morning we have already learned from the MBA what lock desks already knew – that mortgage applications up 4.9% to highest level since May 2009. Refi applications were up 5.7% while purchase only increased .6%. And we have already had the Durable Goods number for July. (In the debatable recovery from March 2009 through April 2010, durable goods orders rose more than 20 %.) Durable Goods were expected to be up between 2 and 3%, but were only up .3%, and ex-Transportation they were down almost 4%. Once again, stocks dropped, and bonds rallied. The 10-yr yield is now at 2.42%, and current coupon mortgage security prices are better by roughly .250 in price. Perhaps we really are headed for a 4% 30-yr fixed rate world on rate sheets. We still have a $36 billion 5-yr. Note auction ahead of us, along with New Home Sales.

Higher 2010 Rate Forecasts All Wrong
At the start of the year, not only were the smartest guys in the room talking about how mortgage rates would go up when the Fed ended their $1.2 trillion purchase program, but that rates would be going up in general given the expected economic rebound. Of course, neither turned out to be true and every originator can’t believe their good fortune by experiencing yet another refi boom, assuming their rolodex has borrowers with equity and decent credit.

Treasury Auctions Next Week
Yesterday’s economic news did nothing to suggest that higher rates will arise in the near future – assuming foreign investors don’t mind the US’s level of debt compared to GDP. The US Treasury said it will sell $109 billion of government debt next week, not far off analysts’ expectations for issuance of $107 billion to $108 billion. The Treasury will sell $7 billion of reopened 30-year TIPS on Monday, then $37 billion of 2-year notes on Tuesday, $36 billion of 5-year notes on Wednesday, and $29 billion of 7-year notes on Thursday.

Economic Stat Roundup
Take Leading Economic Indicators, for example, coming in +.1% but lower than many had hoped. LEI is comprised of 10 series: the factory workweek, new consumer goods orders, nondefense capital goods orders, stock prices, the Treasury yield curve, initial jobless claims, vendor deliveries, building permits, consumer expectations and M2 money supply. Five of the 10 indicators in the leading index contributed to the increase in July, led by the interest-rate spread between the overnight federal funds rate and the yield on the 10-year Treasury note. An increase in the factory workweek and longer delivery times also added to the monthly gauge. Four components retreated, including a drop in consumer expectations and fewer building permits.

The Philadelphia Federal General Economic Index, which like most numbers pales in comparison to the overall European debt crisis, for example, was yet another sign of a slow economy here in the US. It fell to minus 7.7 this month, the lowest reading since July 2009, from 5.1 in July – shrinking for the first time in a year. (Readings less than zero signal contraction in the area covering eastern Pennsylvania, southern New Jersey and Delaware.)

After all of this news, compared with a miserable Jobless Claims number, 2-yr notes sank to another record low yield. If we go into a “double dip”, or, as some believe, never came out of the initial recession to begin with, rates are not going anywhere higher. The signs of weakness are broadening and visible in housing, retail, manufacturing and the labor market (10% unemployment), although GDP in the US is expected to increase roughly 2% in the second half of this year.

(There is no doubt that the mortgage industry has lost a lot of jobs in the last few years. Regarding future job security, one secondary marketing veteran likes to say, “Well, I’m not buying any green bananas.”)

Zillow Survey: 1 in 3 Think Worst For Housing Yet To Come
Zillow, which for better or worse certainly seems to generate a large number of economic indicators, announced that “Homeowner Confidence in Real Estate Market Dips; 1 in 3 Think Worst Is Yet to Come, While 38% Think Local Home Values Have Reached Bottom.”

Mortgage Securitization Paper From NY Fed
At last, the Federal Reserve Bank of NY published a research paper that even I can understand – this time on mortgage-backed securities and certainly worth a read for anyone in secondary marketing and any mortgage sales person. “Most mortgages in the United States are securitized through the agency mortgage-backed-securities (MBS) market. These securities are generally traded on a “to-be-announced,” or TBA, basis. This trading convention significantly improves agency MBS liquidity, leading to lower borrowing costs for households. Evaluation of potential reforms to the U.S. housing finance system should take into account the effects of those reforms on the operation of the TBA market.”

24 Million Own Their Homes Free and Clear
For anyone giving a presentation on the economy, or housing, a good source of numbers and charts comes from our very own Census Bureau. (Yes, they do something besides hire and lay-off large numbers of workers.) Although the actual report won’t be released until around Halloween, the Census Bureau released a number of tables from the 2009 American Housing Survey. For example, there are about 76 million owner occupied housing units, and 24 million of them were owned free and clear! There were 24 million mortgages originated that had an interest rate above 6%.

Rates Net Even Last Two Days After Rising Then Dropping
Wednesday mortgage prices got whacked – you couldn’t give MBS’s away, but yesterday they came roaring back and were “unbuyable”. Origination dropped to a little over $2 billion, but buyers showed up, all types, and it was reported that most of the MBS sales took place in the first few hours of trading. Sales were mostly 4% MBS’s, but there was a smattering of 3.5%’s in order to hedge that 3.75-4.125% production. 30-yr bonds were up (better) by about 1.75 points, dropping down to 3.65% (weren’t we just there with the 10-yr yield?), 10-yr notes were better by over .5 in price dropping to 2.57%.

The economic calendar has zip today as we head into one of the final summer weekends. Bonds traded well overnight – it will be interesting to see if the investor rate sheets catch up a little with the market today. The 10-yr is sitting around 2.55%, and Fannie 4′s are a shade better than the close Thursday.

Loan Costs Up 37% Nationally
Loan costs are up 37% nationally this year, and 41% in Illinois, according to Bankrate Inc. Lenders absorbed a certain portion of this increase as the government began requiring lenders to provide more accurate good faith estimates of closing costs or face penalties. Nationally, average estimated closing costs rose to $3,741 from $2,732. The most expensive state was New York, where costs averaged $5,623, and Texas, where costs averaged $4,708. It includes lenders’ origination fees and title and settlement fees. It does not include property taxes, recording fees or homeowners insurance.

Fate of Fannie & Freddie
Freddie Mac announced that it will be asking for an additional $1.8 billion cash infusion from the Treasury Department after reporting a 2nd quarter loss of $6 billion. ($6 billion is better than the $8 billion lost during the 1st quarter, but still…) These numbers include stock dividends payable to the US Treasury. So I guess Freddie pays a dividend, and then basically asks for it back in order to continue functioning? There continues to be conjecture about Fannie/Freddie’s fate. The latest comes from an ex-Fed Governor, William Poole, and is worth a skim. Ultimately, of course, if those companies leave the US mortgage market, and are replaced by private investors, it will have a huge impact on both small and lenders.

PPI Hotter Than Expected, Other Economic News
Yesterday we learned that U.S. home builder sentiment fell for a third straight month in August to its lowest level in nearly 1-1/2 years, pointing to a weak housing market as the economic recovery loses steam, and our 10-year yield dropped to a 16-month low, closing below 2.60%. $1.8 billion in MBS’s were sold, mostly 3.5′s and 4%. Fannie 4′s finished the day better by about .125.

We have learned this morning that the Producer Price Index was +.2 in July, ex-food & energy it was +.3%, and year over year it was +4.2%. Housing Starts were +1.7% versus a revised number last month. We find the 10-yr yield sitting around 2.60% and mortgages roughly unchanged. Ahead of us we have industrial Production and Capacity Utilization.

And we have the Treasury hosting a summit on how to repair the mortgage-finance system. Some consensus points have emerged, including that any rewrite should include an explicit government guarantee for mortgage investors against a catastrophic collapse. The press wants answers now, but hammering out the details will take months or years.

Rates Lower Still
Mortgage prices rising (agency MBS’s, not non-agency stuff). Not only are all rates dropping, but the spread between Treasury and MBS’s is still fairly tight – further helping mortgages. The demand for agency MBS cash flows is strong, but the primary market can’t churn out enough supply. Investors know that, on average, current mortgages have sparkling credit quality, and that the risk of investing in them is minimal since both Treasury and mortgage securities are firmly backed by the same entity: the US Government. Whatever spread now exists is based not so much on fear of default, but more fear of early pay-off.

Thursday saw a lot of selling in agency MBS’s, but on Friday it dropped off a cliff, nearing $1.2 billion. Regardless, rates continue down. The 10-year U.S. Treasury note yield fell to a fresh 16-month low in Europe today with weakness in Japan and in equity markets stimulating demand for U.S. government debt – we’re down to a yield of 2.62% (weren’t we just around 3%?) and mortgages are better between .125 and .250 in price this morning. Overall it’s a pretty decent news week. Today is the Empire State manufacturing index; tomorrow will be a bigger day with Housing Starts & Building Permits, Industrial Production & Capacity Utilization, and the Producer Price Index. Jobless Claims, Leading Indicators and the Philly Fed manufacturing index will be released on Thursday.

Mortgage Fraud Stories
We’re halfway through August already, and I bet time passes more slowly when one is serving time in prison: mortgage fraud in Seattle and Hawaii.

Better Rates At Smaller Banks?
“Want a Cheaper Mortgage? Go to a Smaller Bank.” I am not saying whether headlines like this are true or false, but these are what the general public tends to see.

“There are two sides to a balance sheet, left and right. On the right side there is nothing left, and on the left side there is nothing right.” On Friday Palos Bank and Trust Company, Illinois, was closed and First Midwest Bank, Illinois, assumed, with the help of the FDIC, all of its deposits.

Low Rates Causing Long Loan Turntimes
Lenders seem to be seeing the proverbial pig going through the snake. “Turn-around times are increasing, and anyone who qualifies and has equity is trying to refi their loan – and FHA borrowers with little to no equity are doing streamline refi’s which do not require an appraisal. In the case of FHA refi’s, they will all close at the end of the month because with FHA loans the borrower owes the existing lender one month of interest, which creates even more of a bottleneck near month-end.” But the general public seems distrustful of the origination community, this is compounded by a confusing regulatory environment, and at the same time lenders are frustrated with borrowers.

Mortgage Bond Positions Of Big Banks
The National Information Center has just released consolidated financial statements for bank holding companies for the 2nd quarter which provides a good early estimate of changes in bank assets and liabilities. The top 50 bank holding companies shed $32 billion of residential MBS’s during the 2nd quarter (agency and non-agency). This decline was led by the top four banks by total assets, whose net position in RMBS declined by the same amount. One bank dropped $22 billion of agency/conventional pass-through securities. Non-agency and commercial MBS holdings declined by $2.2 and $2.3 billion, respectively, for the top 50 banks, but GNMA holdings grew $4 billion and holdings of US Treasuries was up by $8 billion. So why did mortgage securities perform ok? Recent data suggests that banks added $40-50bn in MBS in the past month! Banks change their holdings often, and the report indicated that there was no industry-wide shift in the use of Agency MBS’s.

FHA Mortgage Insurance Increasing October 4
FHA mortgage insurance will be increasing as of October 4, 2010 because the FHA insurance pool only has $3.5 billion in cash and Treasury securities left in its “capital reserve account” The money sitting in the CRA represents a 71% decline in just the last three months. The Mutual Mortgage Insurance Fund (MMIF) capital ratio has fallen below its statutorily mandated threshold. On the good news side of the ledger, from October through June the FHA had 19,310 fewer insurance claims on loans gone bad and paid $3.7 billion less than projected by the audit, perhaps due to solid foreclosure efforts although some feel that this is only because some states are experiencing a backlog in processing foreclosures.

Under HR 5981, FHA plans to adjust its annual mortgage insurance premium (effective with any new loans October 4) from .55% to 1.55%, yielding approximately $300 million per month in value to the FHA Mutual Mortgage Insurance Fund at a time when its reserves are perilously low. To offset this, FHA will lower its upfront premium from 2.25% to 1.25%. This will be effective for 30yr fixed loans. As you can guess, mortgage insurance companies are pleased with this news, since annual FHA premiums will be closer to annual PMI premiums and that could encourage lenders and borrowers to turn to non-FHA products for more mortgages. Borrowers currently shopping for FHA loans should revisit their strategy with their lender given this new news.

Treasury Won’t Increase Underwater Refi Stimulus
The rumor regarding a massive government-sponsored refinancing of over $1 trillion in loans continued to play in the market until it was shut down by a US Treasury official Thursday. The conjecturing, helped along by Jim Pethokoukis’ Reuters blog, spooked the market for high-coupon loans (at this point, anything 5.25% and above), and could certainly be construed as a political gambit. Investors, of course, are counting on that high yield for a few years, so a made-up threat of a huge refinance drove prices down by almost .5 in some areas. The loans that have not refinanced may not, so the risk in owning such high dollar price MBS’s is headline risk like this. “The administration is not considering a change in policy in this area,” said Treasury spokesman Andrew Williams.

Fannie Mae Negative $1.4b Net Worth
What is not a rumor, unfortunately, is Fannie Mae losing $1.2 billion in the 2nd quarter, and asking the U.S. Treasury Department for another $1.5 billion to stay afloat. At this point, are we supposed to say, “No.”? Optimists are quick to point out that this loss is much better than the nearly $15 billion Fannie lost in the same period a year ago. Regardless, this leaves Fannie with a negative net worth of $1.4 billion at the end of June. The company’s regulator, the Federal Housing Finance Agency, asked for $1.5 billion from the Treasury to eliminate the deficit and so the Treasury will buy another chunk of senior preferred stock from Fannie and bring its equity up to about $86 billion. Credit-related costs, which include provisions for loan losses, provisions for losses on loan guarantees and foreclosed property expenses, were $4.9 billion in the most recent quarter. That’s down from $18.8 billion in the second quarter of 2009, Fannie said.

Low Rates Lead To First 3.5% Mortgage Bond Coupon
A new coupon has been created: the Fannie or Freddie 3.5% MBS. Think of it as a bucket for 3.75%-4.125% loans.) Rates have not been this low before, so there was no need for the bucket/MBS coupon. But like someone feeling around in a dark room and not wanting to stub their toe, MBS traders and originators are being very tentative about trading this new 3.5% coupon. Most small and mid-sized mortgage banks are pricing hefty margins into these low note rates and selling this low coupon production on a best efforts basis, letting an accumulator such as Wells or BofA handle the risk. In this uncharted area, liquidity is critical, and the volume of bonds being bought and sold is being carefully watched as acceptance slowly grows.

Mortgage Bond Flows This Week
$2.4 billion flowed into the MBS market yesterday, with the lion’s share being 4% securities. (The 10-yr was up almost .5 in price and the yield closed at 2.91%, the 5-yr Treasury was better by almost .25 which was the same for mortgages.) Of particular interest to investors, however, was the release of the Fannie Mae prepayment speeds, since maintaining cash flows is important if an investor is going to pay a premium for a pool of mortgages. Overall early pay-offs were about as expected, but the recent lower-coupon production has seen a trend of paying off slightly earlier than had been hoped, which is causing some nervousness out there. That being said, lenders know that refinance volumes might be constrained by pricing in order to keep volumes manageable, so that there is a backlog of business out there – which causes even more nervousness among investors since prepays might pick up steam.

Jobs Report Influence On Fed/Markets
Today we had “the big employment number”, certain to influence the Fed’s meeting next week. The pace of the economic recovery continues to rely on private-sector employment growth, which is a problem since in the last 7 months the private sector added only 593,000 jobs. The ADP survey indicates that small firms (1-49 workers) represent about 45% of the level of employment, but accounted for only 16% of the increase in employment over the past five months. And Initial jobless claims have now fallen in three of the last four weeks, but remain stubbornly around 450,000 – weak.

Prior to this morning’s number, interest rates were about unchanged. The data was weak, pushing the dollar and the stock markets down, but has helped interest rates. Nonfarm payroll was -131k for July, with private sector jobs increasing 71k. The headline unemployment rate was at 9.5%, unchanged from June, and Hourly Earnings were +.2%. The yield on the 10-yr has moved down to 2.89% and mortgage security pricing appears to be better by at least .250 – we’ll see if investors pass that onto their rate sheets.

Daily Humor
Boudreaux, a good old boy from South East Louisiana, while not a brilliant scholar, was a gifted portrait artist. His fame grew, and soon people from all over the country were coming to South Louisiana to have portraits done. “Dah boy could paint dat stuff!” they’d say, and it looked good too!
One day, a stretch limo pulled up to his house. Inside the car was a beautiful woman, and she asked Boudreaux if he would paint her in the nude. This was the first time anyone had made this request of Boudreaux. The woman said money was no object; she was willing to pay $50,000.

Not wanting to get into trouble with his wife, Boudreaux asked the woman to wait while he went in the house and conferred with Clotille, his missus. In a few minutes, he returned and said to the lady, “I can do dat, ain’t no big thang. I’ll paint ya in da nude, but I gotta leave my socks on………. so I’ll have a place to wipe my brushes.”