by Calculated Risk on 10/12/2005 11:36:00 AM

Bloomberg reports: U.S. MBA's Mortgage Applications Index Fell 2.6% Last Week

U.S. mortgage applications fell last week to the lowest level since April as higher interest rates slowed both refinancing and home purchases, according to a private group's survey released today.

The Mortgage Bankers Association's gauge of applications declined 2.6 percent to 694.8 in the week ended Oct. 7 from 713.5 the previous week. The last time the index was as low was April 15, when it was 672.6.

The average 30-year fixed mortgage increased to 5.98 percent, the highest since the end of March and the fifth straight rise, according to the bankers group. Higher borrowing costs have caused purchase applications to decline in each of the last four weeks, suggesting home sales are starting to cool.

According to the Mortgage Bankers Association (MBA) the refinance share of activity declined as did the share of ARMs:

The refinance share of mortgage activity decreased to 43.5 percent of total applications from 44.5 percent the previous week. The adjustable-rate mortgage (ARM) share of activity decreased to 29.5 percent of total applications from 29.8 percent the previous week.
...
The average contract interest rate for one-year ARMs increased to 5.26 percent from 5.13 percent one week earlier.

The spread between the 30 year interest rate and the 1 year ARM is now 0.72 basis points; the lowest spread since March 9, 2001.

The Riddles

With rising interest rates, why is the refinance activity so high?

With the narrow spread between fixed rate loans and ARMs (and rising rates) why is anyone using an ARM?

From Bloomberg: Bob Walters, chief economist at Quicken Loans Inc. said they are seeing more people refinance out of their adjustable rate mortgages to fixed-rate mortgages in anticipation of higher borrowing costs. That is a similar explanation as in the LA Times article, "Thinking long-term" that described similar motives of homeowners refinancing their variable rate loans to lock in the security of a fixed rate loan.

This can at least partially explain why refinance activity remains so strong, but I expect that activity to diminish rapidly. With both adjustable and fixed rates rising (and widely advertised to keep rising), those homeowners motivated by locking in a fixed rated will probably refinance soon.

But that doesn't explain the high level of ARM activity. Why is anyone using an ARM today?

Here are two possible explanations: 1) new homebuyers are continuing to stretch to buy a home and 2) existing ARM users are refinancing with ARMs to get a new low teaser rate.

If new homebuyers are using ARMs that is most likely a sign of speculation. With the current spread and direction of rates, I would expect new buyers to use fixed rate loans if they could afford the payments.

The second explanation was described in this LA Times article: Risky 'Exotic' Loans Fostering a Refi Cycle. Apparently many borrowers are desperately replacing existing ARMs and IOs with new ARMs and IOs to forestall higher payments. They are hoping the price appreciation in their homes will bail them out. This is a short term strategy and the day of reckoning is probably soon.

If the riddles are solved, the solutions are not healthy for the housing market. I expect the refinance activity to diminish rapidly and speculation (ARM users) to almost disappear as short term rates rise and the housing market slows.

by Calculated Risk on 10/11/2005 10:30:00 PM

The US Trade Balance for August will be released on Thursday. The concensus is for a deficit of $59.3 Billion or slightly less than the $60.4 Billion record deficit in February. The July trade deficit was $57.9 Billion.

My estimate for the SA petroleum trade deficit is $21.2 Billion or $2.6 Billion worse than the record petroleum deficit in July.

Imports from China will most likely set a record again based on traffic at the west coast ports. My estimate for imports from China (NSA) are just over $22 Billion. Exports to China will probably be under $3.5 Billion. SA this is about the same as July.

My guess for the August deficit: $60.5 Billion. A new record.

by Calculated Risk on 10/11/2005 11:35:00 AM

As a follow up to the previous post, DiMartino writes: Soft landing isn't in cards for U.S.

A report by Morgan Stanley chief economist Stephen Roach highlighted the differences between the rest of the world and us.
...
We're a lot more reliant on the consumer sector, Mr. Roach says:

"The U.S. stands alone in the excesses of consumerism, with personal consumption averaging fully 71 percent of GDP since early 2002 – well above the 67 percent norm that prevailed over the 25-year period, 1975 to 2000."
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The British also had the benefit of having a cushion to fall back on. The personal savings rate in Europe is 14 percent. In Japan it's 8 percent, and in China it's too high – 35 percent.

And here? Well, it doesn't exist. The savings rate has been negative for three straight months.

"Not since 1933 – hardly a comforting comparison – have consumers spent this far beyond their means," Mr. Roach observed. "No other country or economy comes close to matching the American model of excess consumption and negative saving."

DiMartino concludes:

Where are we going?

Home prices have begun declining in some markets. National inventories of new homes are the highest ever recorded, and stocks of existing homes are following in the same straight line upward.

"As sure as night follows day, pricing will follow this inventory overhang," said David Rosenberg, chief economist at Merrill Lynch.

Higher energy prices could not hit at a worse time, and the Fed is still raising interest rates. A soft landing seems like a far-off dream.

"... as night follows day ..."

by Calculated Risk on 10/11/2005 01:30:00 AM

Bloomberg reports: U.K. Retail Sales Fell for a Sixth Month in September, BRC Says

U.K. retail sales fell for a sixth month in September, the British Retail Consortium said, a sign that a slowdown in consumer spending may be worsening.

Sales in stores open at least a year fell 0.8 percent from September last year, the BRC, a London-based lobbying group that represents 80 percent of U.K. retailers, said in an e-mailed report today. That followed a 1 percent decline in August.

It is possible that the UK is a leading indicator for the US, since the Bank of England started raising rates eight months before the Federal Reserve. The BoE started in November of 2003 and the Federal Reserve didn't start raising rates until June, 2004. The discussion now in the UK is of rate cuts:

"It is still too soon to say that things are improving," said Kevin Hawkins, director general of the BRC, in a statement. "The case for a reduction in interest rates is now as pressing as ever."

Investors have increased bets on a further quarter-point reduction by June 2006, interest-rate futures trading shows. The implied rate on the contract maturing that month was 4.25 percent late yesterday ...

Click on graph for larger image.

The graph shows the Fed Funds rate vs. the BoE Repo rate since the beginning of 2001. The question now is when the Fed Funds rate will be higher than the Repo rate.

Sales are especially difficult for the housing related sectors since the housing slowdown has already started in the UK:

MFI, Britain's largest furniture retailer, on Oct. 3 forecast an annual loss after sales dropped 31 percent in the period from Sept. 8. In the preceding 13-week period, sales fell 15 percent.

The average value of a house in the U.K. fell for a second straight month in September and annual home-price inflation slowed to a nine-year low, the Nationwide Building Society said Sept. 29.

Danielle DiMartino of the Dallas Morning News is writing on this topic this week. In Monday's column, she concluded with topics we have discussed:

"Sustained price appreciation has persuaded U.S. households to extract larger and larger amounts of home equity via cash-out refinancing, home-equity borrowing, and the housing turnover process in recent years," Jan Hatzius, senior economist at Goldman Sachs, said in a recent report.

"Judging from the decline in the personal savings rate, much of this mortgage equity withdrawal seems to have found its way into spending," he continued. "That implies a slowdown in house price appreciation is likely to depress mortgage-equity withdrawal and consumer spending."

So, we take our lumps. So, retail spending slows.

And, like Great Britain has just done, we emerge a bit wiser for the experience but relatively unharmed.

Or do we?

On Tuesday, DiMartino promises to outline some of the differences between the UK experience and the US. Hopefully some of the UK experts will critique her analysis!

by Calculated Risk on 10/10/2005 12:44:00 PM

The LA Times has another great article: Risky 'Exotic' Loans Fostering a Refi Cycle

Craig Wolynez is the kind of homeowner stoking fears about a housing bubble.

Even though he had no steady income, the 33-year-old computer consultant and his wife were able to purchase a $416,000 house in the San Fernando Valley two years ago using an "interest-only" mortgage that guarantees low monthly payments for the first five years. After that, Wolynez's payments could rise sharply — making him a prime candidate for default or, even worse, foreclosure.

But like many financially stretched home buyers, Wolynez has a way out: He plans to refinance before his payments balloon. He's now shopping for a new interest-only mortgage that will keep his payments manageable longer.

"There's an urgency," he said. "We know we have to refinance."

Countless home buyers like the Wolynezes sign up for risky mortgages knowing full well they plan to refinance them — or sell their homes — before the payments go up.

And lenders are catering to these marginal buyers:

The mortgage industry not only grasps this refinancing game, it aggressively markets new loans to these borrowers, raking in additional profits from fees and other charges. And lenders continue to devise more creative loans that reduce payments further and extend purchasing power in pricey markets such as California.

"Lenders are putting people into loans where they are almost guaranteed to be refinanced," said George Yacik, vice president of SMR Research Corp., a Hackettstown, N.J.-based financial research firm.

This may work in the short term:

Over time, repeated refinancings could increase the risks of a more severe slump. Already, many fear that homeowners with interest-only mortgages will find themselves "underwater" — owing more than their homes are worth — if prices soften. For the borrower who has refinanced repeatedly, the amount of the debt is likely to be even greater, particularly for those who converted their equity into cash with each new loan or who have paid little or no principal.

Homeowners' ability to continually swap interest-only mortgages not only keeps their payments low for a longer period, it delays the day of reckoning when principal becomes due. As long as home values keep rising, borrowers are protected from becoming overextended.

"So far it's worked out well because they've been able to refinance their way out of trouble," said Keith Gumbinger, vice president of mortgage information publisher HSH Associates.
...
"I don't think refinancing is something people should be doing frequently," said Dean Baker, co-director of the Center for Economic and Policy Research in Washington. "In a falling interest-rate environment you may be saving enough to make it worthwhile. But the mortgage could go bad in the future."

"So far its worked out well ..." So far.