Inflation Pressures Are Easing but Rate Cut Forecast Remains Uncertain

The New Year is beginning where the old one ended -- with uncertainty about when – or whether – the Federal Reserve will begin cutting interest rates.

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Negotiations to resolve the robo-signing mess have hit another stumbling block – the latest in a series of them – further complicating efforts to forge an agreement mortgage lenders and the state attorneys general investigating them can accept and prompting several trade publications to ask in recent headlines: “Are the…mortgage settlement talks falling apart?”

The current dispute has created a rift among the attorneys general themselves, with some refusing to accept the broad-based immunity from future investigations and future liability that lenders view as an essential component of any agreement.

That behind-the-scenes dispute tumbled into public view recently, when state Attorney General Tom Miller, who is coordinating the 50-state investigation, removed New York A.G Eric Schneiderman from the executive committee overseeing the negotiations, complaining that he had undermined efforts to reach a settlement.

Schneiderman has refused to approve a limited settlement focusing on servicing problems alone, but excluding securitization flaws and the complicated array of problems involving the Mortgage Electronic Registration Systems (MERS). MERS facilitated the paperless transfer of mortgages among lenders, investors and servicers, underlying the documentation problems that have triggered myriad lawsuits and snarled foreclosure actions nationwide.

Schneiderman is not the only A.G. to balk at settlement terms that fall short of the broad investigation some think is required. And MERS, a repository for an estimated 65 million mortgages, is a particular target that some state officials, Massachusetts Attorney General Martha Coakley among them, are unwilling to exclude.

“We will make sure, at least here in Massachusetts, that we do not reach an agreement that, for instance, gives relief for securitization issues that still need investigation or for fraudulent servicing around the use of MERS,” Coakley told reporters during a recent press conference. “We will not settle an issue until we know all of the facts and we know all of the damage,” she added.

The Delaware attorney general has joined forces with Schneiderman to pursue a broader investigation of the role Wall Street played in the mortgage meltdown and the California Attorney General is reportedly considering joining that effort as well.

Despite pressure from other attorneys general and, reportedly, from the White House as well to agree to accept a narrower settlement in the interest of ending an investigation that has dragged on for nearly three years, Schneiderman has refused to bend.

"The attorney general remains concerned by any settlement agreement that would fail to provide homeowners meaningful relief to stay in their homes, allow the housing market to begin to recover and get our economy moving again," a spokesman for Schneiderman told the LA Times. "While our federal and state counterparts may be working toward the same goals,” he added, “ongoing investigations by attorneys general cannot be shut down by efforts to settle quickly and those responsible must be held accountable."


Since the subprime mortgage market melted down two years ago, taking the housing market, the economy and (very nearly) the nation’s financial infrastructure down with it, caution has been the by-word for lenders and borrowers. Lenders have tightened their underwriting guidelines, borrowers have moved to shorten their loan terms and pare debt, and both have strongly favored fixed-rate loans, shunning adjustable rate, subprime and other previously popular mortgage alternatives.

But there is some evidence that borrowers and some lenders are beginning to bend. For borrowers, rates as low as 3.25 percent are making adjustable rate loans hard to resist and a dearth of origination activity is making lenders more willing to offer them.

Nearly 12 percent of the new mortgages originated in the first quarter were ARMs, according to Inside Mortgage Finance, up from less than 9 percent in the fourth quarter of last year.

Does this indicate that lenders and a new generation of borrowers are about to repeat the mistakes of their predecessors, offering and accepting loans that will bring payment increases borrowers can’t afford, triggering another round of defaults and foreclosures?

Probably not, according to Guy Cecala, publisher of Inside Mortgge Finance, who says ARMs today bear little resemblance to those that pushed many borrowers and lenders into troubled financial waters.

“By and large, the ARM market was polluted by the abuses that went on with subprime mortgages Cecala told the New York Times. ARMs today come with clearer disclosures and they are going to borrowers with strong credit profiles who understand how the loans work, are probably planning to sell their homes before the first adjustment, and can afford future increases, should they come. As a result, Cecala said, “borrowers and lenders are getting more comfortable with ARMs again.”

Some lenders also appear to be getting more comfortable with borrowers who have less than pristine credit histories. While mainstream lenders – the ones that sell their loans to Fannie and Freddie – are sticking to conservative underwriting standards, analysts say a few private investment firms are beginning to offer loans to borrowers who don’t meet the secondary market requirements.

Lenders in this market insist that while their standards are more flexible – accepting lower credit scores and spotted credit histories and requiring less documentation --they are no less prudent than those of more conservative lenders. Among other things, the rates are higher – up to 13 percent, according to some reports -- and the down payment requirements stiffer – 40 percent on some loans.

“You’d have to be fairly desperate to take that in the current market,” Cecala told the Wall Street Journal, referring to the 13 percent rate some private investment firms are quoting.

The companies insist that their borrowers have strong financial profiles and are good credit risks, even though they don’t meet the stricter secondary market qualifying standards. “There are a lot of good borrowers out there who aren’t being provided for,” Chip Cummings, president of Northwind Financial, a consulting firm, told the WSJ. “Private investment firms are filling that gap.”


While some borrowers are turning to less higher cost and (in some cases higher risk) mortgages to meet their needs (see above), most are following more conservative routes, selecting fixed-rate over adjustable structures, and taking advantage of low rates to pay down their loan balances or reduce their loan terms.

More than 35 percent of the homeowners who refinanced 30-year fixed-rate mortgages in the second quarter selected 15-year or 20-year alternatives – the highest percentage since the third quarter of 2003, according to Freddie Mac. With interest rates averaging 4.65 percent on 30-year loans and 3.84 percent on 15-year mortgages, “It’s no wonder we continue to see strong refinance activity into fixed-rate loans,” Frank Nothaft, Freddie’s chief economist, said in a press statement.

And with the economy still lagging, unemployment rates still high, financial concerns widely shared, and home prices still declining, it is also not surprising that refinancing activity continues to dominate the mortgage market, representing more than 70 percent of second quarter mortgage applications, Freddie Mac reported.

The third quarter has brought no change in those trends. Applications to purchase homes have been hovering near 15-year lows while the refinancing share of the market has approached 8 percent.

The Mortgage Bankers Association (MBA) has revised its forecast for this year, predicting that originations will reach $1.1 trillion –about $10 billion more than the group was projecting earlier this year – based largely on the expectation that low interest rates will continue to fuel a refinancing surge. But MBA analysts have reduced their forecast for home purchase activity to $931 billion, which would be the lowest level since 1997.

Although there are some encouraging signs – mainly the expectation that rates will remain near historic lows – the MBA’s chief economist, Jay Brinkmann, said, "Nothing in the housing market data suggests any significant change from our previous expectation of a frustratingly slow period with lackluster sales volumes,” in the near term.


Although critics continue to promote proposals that would eliminate Fannie Mae and Freddie Mac or significantly downsize them, the giant government services enterprises (GSEs) continue to anchor the home finance system – and they continue to require federal financial support to do so.

Operating under federal conservatorship, both entities are still losing money, according to recent reports, although the speed and size of the losses have declined. Fannie Mae has requested another $5 million from the Treasury after reporting a $2.9 billion loss for the second quarter of this year –an improvement over the $6.5 billion loss reported for the first quarter, but a move in the wrong direction compared with the year-ago loss of only $1.2 billion. “Continued weakness in the housing and market markets,” compounded by a weak economy and declining home prices were primarily responsible for the negative numbers, Fannie officials said.

“We are focused on reducing taxpayer exposure by limiting our credit losses and building a strong new book of business,” Michael Williams, Fannie’s president and CEO, said in a press statement. “Our new book of business is now nearly half of our overall single-family book and we expect these new loans will be profitable over their lifetime.”

Freddie Mac also wrote its second quarter results in red ink - $2.1 billion of it. That was smaller than Fannie’s loss and a significant improvement over the $4.7 billion loss Freddie reported for the same period last year.

Like Fannie, Freddie has also requested additional federal funding, but the $1.5 billion in assistance the company is seeking is being offset by a $1.6 billion dividend payment the company made in the second quarter, increasing to $13.2 billion the total it has repaid the government since entering conservatorship three years ago. Freddie still owes about $53 billion and Fannie nearly $90 billion.


It wasn’t easy, but we found some good news about the mortgage market: Default rates appear to be improving. Two recent reports – one from University Financial Associates (UFA) and the other from S&P/Experian have highlighted that trend based on their proprietary market gauges. UFA’s default risk index declined to 132 in the second quarter of this year, down from 133 in the first quarter and down significantly from the 141 recorded in the first quarter of 2010. The current reading is also “much less than the worst vintages of this cycle,” the UFA report noted, referring to loans originated between 2006 and 2008 that have produced soaring delinquency and foreclosure rates over the past three years.

“Mortgage risks may be returning to near normal levels,” Dennis Cappozza, a professor of business administration at the University of Michigan and a founding principal of UFA, told DS News. At the current rate of improvement, he suggested, “normalcy may not be far away.”

The S&P/Experian “Consumer Credit Default” indices also recorded improvements in both the month-to-month and year-over-year rates. The default rate on first mortgages fell to 1.93 percent in July compared with 2.02 in June and 3.25 percent a year ago; the second mortgge default rate declined from 2.77 percent a year ago to 1.4 percent.

“By and large, July’s data support the downward trend we have observed over the past two years,” David Blitzer, managing director and chairman of the Index Committee for S&P Indices, said in a press statement. “Despite high unemployment rates, consumers continue to improve their financial positions, resulting in lower default rates than we were seeing during the recession,” he added.

Of course, in the current environment, every scrap of good news is offset by less encouraging data and the default reports are no exception. The Mortgage Bankers Association reports that delinquencies on residential mortgages increased in the second quarter compared with the first, reversing what had been an encouraging downward trend. The increase – only 12 basis points – was small, but the trend is still troubling, industry analysts agree.

“Most worrying” to Paul Dales, senior U.S. economist with Capital Economics, is the fact that the delinquency rise was driven entirely by an increase in the number of homeowners falling behind in their payments for the first time. “The weaker economy and rebound in the unemployment rate are already taking their toll on the housing market,” he told DS News.

Sixty-day delinquencies, by contrast, increased by only 2 basis points and delinquencies of 90 days or more declined a little, representing “the good news” in the report, Jay Brinkmann, the MBA’s chief economist said. But the increase in newly delinquent loans offset that positive development, he acknowledged. It is clear, he said, that “the downward trend we saw through most of 2010 has stopped….Mortgage delinquencies are no longer improving and are now showing some signs of worsening.”