Ride The Storm, Part 2: Markets Don’t Die, They Just Evolve

In our first quarterly report of 2008, we proposed “Ride The Storm” as phrase of the year, and discussed how aggressive Fed rate cuts and higher conforming loan limits might “break the storm clouds” in mortgage and financial markets.

As 2008 moved on, 85-year-old investment bank Bear Stearns collapsed, Congress passed two economic and housing stimulus packages, and 25 banks plus hundreds of mortgage firms failed.

In September alone, Fannie Mae and Freddie Mac—firms that own or guarantee half of America’s $12 trillion mortgage market—were taken over by the Treasury Department; Insurance giant AIG received a $100 billion+ government bailout; WAMU was taken over by JP Morgan Chase; Wachovia was taken over by Wells Fargo; investment banking went extinct as Lehman Brothers filed bankruptcy, Merrill Lynch was acquired by Bank of America, and Morgan Stanley and Goldman Sachs converted to commercial banks; most hedge funds posted their worst month in decades; and Treasury was authorized to directly invest $700b into ailing financial firms.

With bailouts deepening in financial, auto and other sectors, and yet another massive economic stimulus plan in the works, stocks can move in 1000-point ranges and mortgage rates can move up or down by 0.5% in single trading days.

Given the market chaos and radical adjustments to policy and tactics made by the Federal Reserve, Treasury and FDIC, it seems quaint that we were talking about mere Fed rate cuts and loan limits as 2008 kicked off. But we got one thing right: businesses and consumers had to Ride The Storm all year.

Market Observer Scenarios
To see where 2009 takes us, let’s look at a bearish but credible market analyst. Nouriel Roubini, Chairman of RGE Monitor and Professor of Economics at NYU, has been warning about an impending crisis since 2004. His projections call for a 12 to 24 month recession that will bring unemployment to 9% (from 6.7% now), pull national home prices down another 15%, and amount to $3 trillion in total bank losses—more than triple the $637 billion in losses compiled by Bloomberg as of early-December.

Roubini has also been prescient in his recommendations for solutions, calling for “a rapid resolution of the banking problems via triage, public recapitalization of financial institutions and reduction of the debt burden of distressed households and borrowers.”

With Treasury’s insistence that they be free to allocate the $700b in rescue funds according to market circumstances, plus new loan modification programs by Fannie, Freddie, Citibank, JP Morgan Chase, and others, we see that market players are doing exactly what Roubini has suggested.

These measures may not stave off another 2.3% jump in unemployment, and with banks doing massive reductions on loan balances, $3 trillion in losses seems plausible. But if consumers get to stay in their homes because of these loan balance modifications, that could mitigate further drops in home prices.

Market Participant Scenarios
If we compare the views of market observers like Roubini with market participants like Bill Gross, head of PIMCO, the worlds largest bond investor, we see Gross is no less realistic about recession scenarios. But his firm must slog through this crisis with skin in the game—just like we all do as consumers and homeowners—so they are investing. Which reminds us that markets don’t die, they just evolve.

In the near-term, PIMCO believes mortgage-backed bonds issued by Fannie/Freddie are a great investment. Buying from firms like PIMCO plus the Fed’s commitment to buy up to $500b of these bonds continues to drive 30-year fixed rates to record lows.

PIMCO has also upped positions in bonds and preferred stock of banks where Treasury has invested because they say, “with Uncle Sam as your partner, default seems remote.” With big investors backing the banking sector, it will eventually help economic recovery.

And PIMCO believes short-term Fed Rates will stay low for “an extended period of time” as government intervention plays out, then the effect this intervention will create inflation. This will cause long-term rates, including mortgage rates, to rise.

Your Own Scenarios
All of this background suggests that very low rates and property prices are likely for 2009 and perhaps longer. And when an economic recovery does begin, rates could rise quickly. So monitoring your local market for the right time to invest in property is important. You need to find qualified, experienced mortgage professionals who can help you conduct this analysis of your specific financial situation and the local real estate conditions in your area.

The goal is to find lending and real estate professionals that understand you and are riding this storm with you so whether you need to work through a serious problem or map out your bargain-hunting strategy, they’re motivated by your best long-term interest and not by their compensation. If they’re a true market participant like you, it should be pretty obvious when you’re screening them. If you reference the topics covered in this article and they don’t have straight answers for you or stumble, move onto the next one.