WeeklyBasis 1/29/09: Rate Lock Primer, Stimulus Overview, Bank Bailout Part 2

Rates have traded in a half-point range in the two weeks since my last report. This kind of volatility is standard right now as markets struggle to reconcile dismal economic news with massive government stimulus. It’s somewhat futile to display rates at the bottom of this report because they swing so wildly each day. Zero-points rates are displayed but most lenders are pricing rates right now such that one-point rates are significantly better—normally one point gets borrower about .25% to .375% lower in rate, now it gets .625% to .875% lower in rate. This means borrowers break even on a one-point buydown in about 18 months.

The approach to locking remains what it has been for the past year, which is a trader’s approach of setting a rate target and locking when market trading leads us to the target. The “normal market” approach of using macroeconomic predictions for the week or month to predict rate levels is out the window because markets are simply too erratic to make any accurate predictions. So instead we look at trading patterns in mortgage bonds.

Between the November 24 Fed announcement that they’d buy up to $500b in mortgage bonds to bring rates down and the first MBS purchase by the Fed on January 5, rates dropped 1.25%. This was from private investors piling into bonds ahead of the government. Bond yields/rates drop when bond prices rise on a buying rally, and yields/rates rise on selling pressure.

As of January 21, their third week into the buying program, the Fed had bought $52.6b of mortgage bonds and the next buying report comes out tonight. Yesterday after their first FOMC meeting of the year, the Fed left short-term overnight rates alone at .25% but said they’d continue to buy mortgage bonds and may extend beyond $500b and beyond June if needed.

For those still holding out for 4.5% rates, this is yet another reminder about how rates on all loans up to $625k are openly traded. Fed buying was targeting lower rate ranges but as I’ve been saying for weeks, a good 30yr fixed rate target for loans up to $417k is about 5% and the target for loans up to $625k is around 5.25%. It’s possible to dip below those levels on certain trading days, but like buying stocks, locking rates is an exercise in determining your price target and executing—greed will cause more headaches than celebrations.

Rates for loans from $625k to $1m are mid-6% range, but remember, these rates are not currently set by trading because these loans are not securitized—these rates are the only rates right now set manually by banks.

The reason I think rates are not likely to go significantly lower and stay there is because of the private selling pressure in mortgage bonds that mutes the impact that Fed purchases can have. All this said, the Fed’s actions should keep rates on loans up to $625k within their current trading range for the next 30-60 days, perhaps longer.

The House of Representatives passed an $819b tax and spending bill yesterday on a vote of 244-188, with 11 Democrats opposing it and zero Republican votes. The bill includes about $544B in federal spending and $275B in tax cuts for individuals and businesses. There is a Senate vote next week on a similar $900b package, and Obama is pushing for reconciliation between the two bills by February 13.

This is important but bank bailout plans are perhaps more important because credit is still the lifeblood of the consumer and business segments of GDP growth (4Q GDP out tomorrow), and there are two schools of thought here and the TARP so far has represented both. The TARP was originally proposed to buy up illiquid assets from banks to enable them to clean up balance sheets and get back to core activities. In the two weeks it took to get approved, the financial crisis was going through one of its worst phases (late-September), and it was determined that the best approach was to do direct capital injections into banks.

These two approaches remain at the center of the debate. The ‘bad bank’ proposal uses the first approach. The shortcoming here is what it’s always been: how do you ensure taxpayer dollars are not overpaying for bad assets? Nobody knows precisely how to price these securities. This plan was abandoned in round one for this reason and because there was no time to price the assets after the Lehman domino fell. Given some time, the FDIC might be able to pull this off.

The other approach is direct capital injections into banks which is what round one of the TARP ended up doing. But they did it with absolutely no prerequisites for banks. Banks must be forced re-deploy capital they receive and may even need capital requirements lowered temporarily so they don’t feel forced to hoard government infusions. George Soros thinks this is the better approach, but said it would take about $1 trillion to work.

He accurately pointed out that TARP phase one rattled politicians to the point that we might not get a logical decision in round two either. But let’s hope the new administration and Congress can cut through the rhetoric and see the bank proposals for what they are: the only path to recovery.

Conforming ($200,000 – $417,000) – NO POINTS
30 Year: 5.625% (5.74% APR)
15 Year: 5.5% (5.61% APR)
5/1 ARM: 6.25% (6.49% APR)

Super-Conforming ($417,001 to $625,500 cap by county) – NO POINTS
30 Year: 5.75% (5.87% APR)

Jumbo ($625,500 – $1,000,000) – NO POINTS
30 Year: 6.65 % (6.76% APR)
10/1 ARM: 6.35% (6.46% APR)
7/1 ARM: 6.05 % (6.16% APR)

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