Will Rate Cuts Save The Economy?
The problems we are facing now are a direct result of too loose a monetary policy at the Fed.
The question of the day is "Will interests rate cut by the Fed save housing and the economy?"
Jim Cramer Says "Yes"
Jim Cramer's opinion can be seen in Financial TV host flips out over the state of the economy.
(Click on the above image to see Cramer in action)
But the Answer is "No"
So we've seen what Cramer has to say, let's take a serious look at whether Fed rates cuts will save the economy and why I believe the answer must be "no".
The first reason is that long term rates (the 10 year Treasury) simply may not decline when the Fed starts cutting. Does anyone remember "Greenspan's Conundrum"? If not, Greenspan was perplexed as to why long-term rates did not rise much as a series of 17 consecutive rate hikes by the Fed were made. On that basis it is therefore entirely possible that when the Fed starts cutting (and they will), that long term treasury rates may not follow. Clever readers will now be asking "Wait a second Mish, you said may and now you are presuming will. What gives?"
That brings up reason number two. Everyone knows mortgage rates are directly tied to the 10 year Treasury note. Or are they? I have been stating for well over a year that mortgage rates would disconnect from the 10 year Treasury note. My reason was simple: increasing default risk would eventually force it.
While the "Reverse Conundrum Hypothesis" is indeed just that (it may or may not happen and now I think that it won't but it could), the 10-year versus mortgage rate disconnect is no longer a theory. Eventually, it arrived. The disconnect is now well underway. It started in June and has blown wide open in the last two weeks.
Consider the following chart of treasury yields for the past 12 months.
$TNX - Treasury Yields
(Click on the chart for a crisper view)
The above chart shows all the major rallies and declines in the 10 year treasury over the past year in basis points.
Bankrate.com 30 Year Fixed Mortgage Rates
(Basis points are approximate given chart scales)
Major Moves: Treasuries vs. 30 Year Fixed Mortgages
32 basis points versus 20 basis points
44 basis points versus 37 basis points
43 basis points versus 22 basis points
84 basis points versus 74 basis points
60 basis points versus 13 basis points
Look at those last two data points closely.
An 84 basis point rally in the 10 year led to a 74 basis point hike in mortgage rates.
On the subsequent decline of 60 basis points only 13 were picked up in mortgage rates.
But it's not even that good. Not even close.
Bankrate.com 30 Year Fixed Mortgage Rate Jumbos
Jumbo rates went up, even with that substantial rally in treasuries.
Bankrate.com 5/1 ARMs
5/1 ARMs are similar to 30 year fixed but for all the additional risk, the consumer is saving a mere 25 basis points.
All of the above charts are for Prime Loans, with good credit scores, and a down payment. Inquiring minds are no doubt wondering what happens in other conditions.
Major Disconnect in Subprime
Late last Friday I gave a call to Dave Donhoff at No Bull Mortgage and was wondering about subprime and Alt-A, and how they were affected by these treasury gyrations. Before I go further, let me say that Dave is one of the good guys. He has not had a single returned loan or foreclosure on one of his customers in the last six years. Although Dave has not been tracking exactly what I wanted, he did offer this:
- Almost all stated income loans everywhere vanished last Friday.
- Almost all 2/28 ARMs vanished last Friday.
- While this was eventually expected it was not expected by everyone overnight.
As we were talking I was fortunate that a representative of major mortgage lender who had a scheduled appointment stopped by to see Dave. That person agreed to talk to me on condition of anonymity so I will honor the request. But here is what I found out from that major lending insider.
- Subprime rates have risen by as much as 190 basis points at his organization in just the last 2 weeks!
- Many other lending institutions have done the same thing.
- The definition of prime has tightened considerably, everywhere.
- Any variance from prime raises the mortgage rate.
- Small differences in FICO score now matter (sometimes by a lot).
- Every little thing adds up.
- 90% LTV rates are higher than 85% LTV rates which are higher than 80% LTV rates.
- 100% LTV rates are very difficult to come for subprime and even Alt-A.
- Condos versus homes matters significantly.
- There were three rate increases in the last two weeks even as 10 year treasury rates rallied.
- Second mortgages have nearly vanished - no market.
- 2/28 ARMs - gone.
- Someone who is "really clean" but is not prime (but close) and is putting down 20% has had a 70-80 basis point hike in the last 2 weeks.
- The bankrate charts might not show it, but in the last two weeks nearly every loan rate went up even as treasuries rallied significantly. The primest of prime was perhaps flat.
A 190 basis point hike in two weeks was so shocking that I asked for a repeat. "90?" I asked. "No, that's 190 basis points," came the reply. For those not familiar with the term basis points, 100 basis points is a 1% rise in the loan rate. For example, 190 basis points would send a mortgage loan from 7% to 8.9%. The bigger the loan the bigger the increase in monthly payments (ouch!).
Virtually any subprime borrower whose ARM is due to reset later this year or early next year and has not yet rolled over the loan is obviously in deep trouble, regardless of what the Fed does or does not do. Not only is the teaser rate itself going to rise dramatically because of the rising treasury rates, the risk component has risen as much as 190 basis points in addition to that.
Furthermore, anyone in a stated income loan, anyone with a second mortgage, anyone in a pay option arm, or anyone in a 2/28 is now locked out of all those options. (Please see Locked Out for more on what's happening, through the eyes of Bankrate.com). And finally, as Dave Donhoff put it to me, "Many buyers are discovering there is a difference between quoted rates and actual availability of funding at those rates".
Let's Assume A Miracle
But let's assume a miracle. Let's assume that the Fed cuts rates 100 basis points in a surprise move on the advice of Cramer, interest rate spreads plunge, there is no treasury/mortgage rate disconnect, the 10 year treasury rate drops significantly, mortgage rates follow the 10 year rate lower, fixed rate mortgages at reasonable rates are offered to everyone regardless of credit risk, and the US dollar does not blow up in response. Wow. Nonetheless, let's assume that Miracles R Us grants all that as a single miracle request. Unfortunately there are still two sticky questions to resolve.
1) Is the consumer out of the woods?
2) Is the economy out of the woods?
The answer to both questions is still no. Remember that foreclosures are massively rising even though the bulk of interest rates resets is still upcoming. Many of those teaser rates were put in place as the Fed slashed rates to 1%. Cramer simply did not ask for enough.
Consumers need not only lower rates, but the initial teaser rates they had (if not even lower). So let's assume still another miracle: mortgage rates reset at the prior teaser rate lows regardless of risk, negative amortization, or worsening FICO scores of the applicants.
Inquiring minds are no doubt asking why even more miracles may be needed. The reasons center around debt servicing and jobs. There is simply no pent up demand for housing, no growth in wages, and no way cash strapped consumers can service current debt loads. There is also no source of jobs that an overheated housing market created. There is no need for more Home Depots (HD), Lowes (LOW), Pizza Huts (YUM), Applebees (APPB), nail salons, strip malls, Walmarts, etc etc. In fact there is a need for less stores not more and the coming consumer led recession will prove it. Overcapacity is simply rampant. It would take even more miracles to correct all of that.
Is there pent up consumer demand in anything? If there is, why is Wal-Mart (WMT) slashing prices on 16,000 items smack in the face of rising energy prices? (Please see Price Wars for an explanation). July had the worst decline in US auto sales in years. Is a rate cut supposed to cure that?
The jobs picture is weak and hiring is not even keeping up with the birth rate plus immigration as explained in Martian Economists and BLS Moonbats. And unless more miracles are granted, this is the end of the line for unnecessary corporate expansion.
Oh sure, Starbucks will add another 15,000 stores or whatever (perhaps) but will they be in the U.S. or China or India? So where is the replacement for U.S. jobs that housing provided is supposed to come from?
Corporate Profits Have Peaked
The merger mania, buyout bingo, CDO, and LBO parties each went on longer than anyone expected. But the parties are now clearly over. And all of those parties added enormous up-front profits to the pockets of broker dealers like Merrill Lynch, Goldman Sachs, Lehman, and scores of hedge funds.
It took about a year longer than expected for subprime to blow up. But Lenders are now blowing up in a magnificent display of fireworks. The Mortgage Lender Implode-O-Meter is at 109 as I type, and more implosions are added every week. By the way, Implode-O-Meter is being sued and a summary judgment to dismiss the lawsuit was tossed. For more information please see Judge Franklin R. Taft Denies Ml-Implode Motion To Strike via Anti-SLAPP.
Expect far fewer stock buybacks on borrowed money, far fewer leveraged buyouts and tighter lending conditions all across the board regardless of what the Fed does or does not do. And we still have not seen enough write downs related to subprime slime. Of $565 billion in subprime loans made in 2005-2006 (the worst years), a mere 2-3% of that has been downgraded by the chickens and sheep at Moody's, Fitch, and the S&P. See Thoughts on Moody's "Tough Stance" for how Moody's is attempting to play the victim in this mess when in fact they are a big part of the problem.
Although the asset side of the balance sheet seems pretty good, it is a complete illusion. The debt side of the balance sheet has never been greater. When assets take a hit (and they will), the debt will still be there acting like an anchor for years to come and/or until massive bankruptcies wipe that debt off the face of the earth.
No matter how one twists and turns, logic dictates that several major miracles as well as massive positive assumptions about those miracles would still not be enough to revive either housing or this economy.
The problems we are facing now are a direct result of too loose a monetary policy at the Fed. Slashing interest rates to 1% cannot be the cure if slashing interest rates to 1% was the problem. Careful analysis thus shows that Cramer is now asking Bernanke to make the very same mistakes Greenspan is accused of having made.
Some are slower than others, but by now everyone (including Cramer and the Fed) should be realizing that it was the Fed's miracle financing that caused the corporate malinvestments, overcapacity, and consumer debt hangover problems we now face in teh first palce. Miracle financing caused the problems, so miracle financing sure won't be the cure. The miracles have now run out and the party is over regardless of what the Fed does or does not do. It's as simple as that.
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