MORTGAGE CREDIT NEWS BY LOUIS S BARNES - March 6, 2020

Wuhan or no Wuhan, again take a deep breath. Then as always break things down into components.

First, and then in detail below: all public information today about mortgage interest rates is mistaken. Yes, the 10-year Treasury fell to 0.73% last night -- from 1.52% two weeks ago! -- and mortgages should have followed all the way down to 3.00% or below. And have not. Rates in the low threes available last week without points now have points. Freddie Mac’s survey found 3.29% with .7-point, surprisingly correct. Why will take some explaining.

We are in a multi-generational global health crisis. I am old enough to remember the relief on our parents’ faces when we lined up to get our polio vaccination. Nothing like that in the 65 years since. Wuhan has begun to spread in the US, and national leadership is AWOL. Yet, so far there is no damage to the US economy. This week we got reliable data from late February, and if anything jobs and business activity were accelerating.

But markets are in the business of discounting the future. And keep markets separate! Stocks and bonds move for different reasons. Stocks were overbought because there was nothing else worth buying, and the Fed said not to fear hikes. Stocks are sinking because of profit-taking and the future potential of Wuhan economic damage.

Wuhan broke into emergency status near the end of January, and the bond market reacted normally into the third week of February, rates falling as frightened money bought for safety. As always in an international panic, money goes to Treasurys first, mortgages trailing. MBS are weird even to Wall Street natives. Because US mortgages have no prepayment penalties -- $11 trillion in IOUs -- no investor can know how long one will last. If rates fall, then the borrower refis and extinguishes the mortgage; if rates rise, mortgages last until doomsday. Thus most mortgage holdings are hedged by counter-trades in Treasurys and swaps. All based on probabilities of future refi or extended life, and everybody uses the same math.

The basic hedging strategies which moved mortgages from S&Ls and banks to Wall Street began in 1983. These hedges -- derivatives, that scary word -- deal with rate risk and have worked exceptionally well. The 2008 mortgage disaster involved truly stupid and deceptive efforts to derivatize credit risk. Interest rate derivatives have had briefly bad moments: during the surprise drop in oil prices in 1986; reacting to the Fed death march surprise in 1994; the surprise Russia default and LTCM collapse in 1998; the surprising threat of deflation in 2001 followed by 9/11; the mother of all surprises 2007-2008; and Europe surprises in 2012 and 2016.

Note “surprise.” Hedging math is based on back-look probabilities, not absolute risk. If an event blows through those probabilities... oh, my. Everyone hedged for safety suddenly has greater risk, forced to re-hedge the busted ones, which results is perfectly rational but suicidal trading. Mortgages at the center: if mortgages rates fall far enough to blow out all estimates of how fast existing loans will be extinguished by refi, the holders of trillions in investments must -- must -- race to buy Treasurys to re-hedge, which pulls rates down farther, blows more hedges, forces more buying and rates lower until...
Until now. The whole mortgage machine has locked up, unable to digest volume. Intestinal blockage. Martha, we have a plumbing problem: some is running too fast, some not at all. No investor wants to pay a premium (a credit to the borrower, closing cost coverage), or even full price “par” for a loan which will re-refi in months. As the blockage worsened, loans to investors became two-point loans in the mid-fours. By mid-week, ordinary owner-occupied loans could be had only by paying points, no matter how high the rate, more expensive than three weeks ago, no matter what the 10-year T-note has done.

“Profiteering!” some say. We profit from catastrophes by closing volumes of loans, and now can’t. To say that loan officers are frustrated, or that consumers are impatient and disbelieving, and can’t imagine conditions inside the mortgage machine... understatements of the century.

Resolution? Time, most likely. Weeks to months. Fed rate cuts are nearly meaningless. The Fed might revive QE for the reason it first announced in November 2008: to bring liquidity back to locked-up markets. The spread then between 10-year Treasurys and retail mortgages was almost as wide as now. The Fed’s two oldest and most central tasks: be the bidder of last resort, buy when no one else will, and second, maintain orderly markets. Panic in stocks and bonds conceals accurate pricing, feeding on itself. Liquidation is necessary from time to time, but must be orderly.

Dear consumers: let us know what rate and terms you’ll take, and we or someone will get to you when we can. Rates are likely to stay down for a long time. We are near mortgage absolute zero: even in a global recession it will be hard for 30-fixed no-point loans to fall more than an inch below 3.00%.

Rates will U-turn upward if Wuhan resolves. A vaccine may be a year away. Effective treatment and triage, sooner. Understanding of contagion, the true number of infected including those without symptoms and ignored or concealed by nose-counters... more on that daily. Mortality is likely higher than ordinary seasonal flu, but much below 1% with decent medical care. I run into more people all the time who are ready for us all to be exposed, get this over with. Hysterical quarantine damages the economy, not the virus.

Then to entertainment. The Democrats have selected the ATM. Not a cash machine or tank-killer, but the Anti-Trump Missile. It will be Biden, even if they have to prop him up like El Cid on his horse. Too much going on in markets to detect impact, if any.
See below to maintain a sense of our absurdity. :-)

The 10-year T-note in the last year, not that it matters:

The ECRI from one week ago has nosed over, likely because of the weight to stocks and the 10-year in its model. Hardly a nose-dive:

“Hysterical quarantine hurts the economy, not the virus.” These images show nitrous oxide in China’s atmosphere -- pollution from autos, primarily:

Consumers and lenders alike feel just like Scrat:

The mortgage machine today is Lucille and Ethel in the chocolate factory: https://www.youtube.com/watch?v=_y0nsN4px10