Houston Mortgage Market Update: August 25, 2008

Following is a great update on the most recent changes in the mortgage industry as originally distributed by Shane Price with Houston Capital Mortgage.

When someone is surprised it means he is “not well-calibrated.” In layman’s terms, his expected range of outcomes was too narrow.

That was the case last week with most economists, for their range of expected outcomes of the producer price index was too narrow. Producer price inflation hit 1.2% in July; more than double the consensus estimate.

Why the economists were so wrong is puzzling, considering oil hit $147/barrel in July. That increase alone would naturally spike producer prices.

Nervous economists now warn that producers will pass their energy costs on to consumers, further stoking inflation.

Or maybe not; credit markets believe otherwise. Ten-year Treasury notes continue to fall, and now yield around 3.8%, compared with 4.6% a year ago.

Mortgage rates are showing signs of easing as well. The prime 30-year fixed-rate mortgage dropped to 6.7%, the prime 15-year fixed-rate mortgage fell to 6.2%, and the prime 5/1 adjustable-rate mortgage eased to 6.3%, according to Bankrate.com’s most recent survey.

These same economists also proved themselves to be “not well-calibrated” when data on new-home starts was released. Many predicted new homes would fall to a 950,000 annual rate. It didn’t; it posted at an annual rate of 965,000.

But other economists are “well-calibrated,” correctly forecasting Fannie Mae’s and Freddie Mac’s demise.

It appears the end is near for Fannie’s and Freddie’s investors. The two mortgage giants have recorded almost $15 billion in combined losses in the past four quarters, decimating their capital base.

Fannie’s and Freddie’s stock touched 20-year lows last week on speculation a government bailout will leave their stock worthless. (The stock symbols are FNM and FRE if you care to see how fast and furious the fall has been.)

But there is no need to worry if you’re not an investor; Fannie and Freddie aren’t going anywhere. U.S. Treasury Secretary Henry Paulson won approval from Congress last month to pump emergency capital into the companies, so they will continue their primary role of buying and securitizing residential mortgages.

Is It Time to Nationalize Fannie and Freddie?

Fannie Mae’s and Freddie Mac’s impact on the mortgage market can’t be overstated. Both borrow huge sums of money to buy mortgages.

Their demand is a major force in setting the overall rate on standard mortgages, particularly now that many other sources of financing have evaporated. And even though both companies have recently been purchasing larger amounts of mortgages, rates on mortgage loans have stayed relatively high.

If the government believes cheaper borrowing costs are central to a housing recovery, it will have to do something to get mortgage rates to decline in line with Treasury rates.

One guaranteed way to lower the spread between Treasury and mortgage rates is for the government to take over Fannie and Freddie. A takeover would lower Fannie’s and Freddie’s borrowing costs, which, in turn, would lower mortgage rates.

More competition from the private sector is another, though less timely, solution.

Nationalizing Fannie and Freddie would drop mortgage rates immediately, to be sure, but few private firms would be able to match Fannie’s and Freddie’s borrowing costs.

That would mean less innovation and fewer mortgage options for borrowers, and that could hurt the housing and mortgage markets in the long run.