The 10-year Treasury failed again to break below the 4.53 percent bottom, a level tested again and again since September, so mortgages are stuck just above 6 percent.
This week’s test and failure was different from the prior ones: the other rallies were broken by surprisingly strong economic data, especially the last two monthly payroll reports. This week the bond market got exactly the bad news it was hoping for: huge drops in wholesale and consumer prices, an off-the-table report on new-home construction, and minimal up-ticks in retail sales and industrial output.
Background items offset some of the benefit of bad news: the Fed’s October minutes contained not a syllable about a rate cut, and instead unanimous concern for inflation. Also, some housing numbers hint that the worst is over, and the slowdown isn’t hurting the economy much, anyway. Purchase loan applications bottomed in late summer, un-sold inventories of homes are no longer rising, rapid household formation will support demand, and a retreat by builders is good news, not bad.
Greenspan’s Conundrum remains: if the economy is OK, and the Fed not about to cut its rate, why are long bonds trading .75 percent below the Fed? This “inverted yield curve” should predict recession and Fed rate cuts, but every day passing it seems less a predictor than a result of these four things: new wealth chasing long-term return; pension and insurance need for long-term assets to cover liabilities from an aging world; a shortage of long-dated high-quality collateral to back up new-age derivatives; and a gross underestimation of future risk, inflation and otherwise.
Those forces exert considerable buying pressure, which is protecting bonds and mortgages from what would otherwise be a bad upward pounding after three months of failed rallies. The next shot at lower won’t appear until Dec. 8, when we get November payrolls. Everyone in the bond market will, of course, hope that a couple of million people have been thrown out of work just in time for the holidays.
OK: now tie the inverted yield curve to mortgages and housing….
Every one of the catastrophic Housing Bubble stories has the pending reset of ARM rates as a centerpiece, and they are wrong. We might have a recession, it might be led by housing, and something awful might happen to housing prices, but the reset of rates on ordinary ARMs won’t be the cause.
ARM rates are resetting, as all indices sooner or later follow the Fed upward. The quick-movers, LIBOR and T-bills, have been above 5 percent for months; now even the slow-movers, COFI and MTA, are up to 4.32 percent and 5.03 percent, respectively, COFI still with a ways to go. Add typical margins of 2.25 percent to 2.75 percent, and there’s a trillion or two worth of these poor ideas headed to 7.5 percent in the next three years.
At the ARM low from ’02-’04, consumers elbowed at the teaser-rate trough for 5-year hybrid ARMs near 4 percent, so the coming reset will be an average 3.5 percent rate increase — depending on caps, in two successive adjustments, or all in one whack.
Three-point-five percent is a big whack, but a disaster only for the handful who thought that 4 percent was a lifetime contract. A 3.5 percent rise in rate translates to about a 45 percent increase in p&i payment, tax deductible, t&i unchanged — merely annoying to most borrowers, who knew the initial deal was artificial. Note also that average mortgage balances have not risen remotely as fast as home prices; payments will rise, but wealth rose faster.
Missing in the Bubble Apocalypse: nobody has to suffer the 3.5 percent reset! Because of the negative curve, anybody can refinance today to a rate close to 6 percent without loan fees. That’s only a two-point reset, a 25 percent rise in p&i cost. As a recessionary drag on the economy … peanuts.
If fixed mortgage rates were today where they were in the ’90s, up at 8 percent when the Fed was at 5.25 percent, then this generation might learn the real hazards of ARMs. Not this time, and the borrowers don’t even know how lucky they’ve been.
Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at lbarnes@boulderwest.com.
