March 29, 2010 — In just three business days we will start to find out
the effects of the end of the Federal Reserve program of purchasing
mortgage-backed securities to keep interest rates low. It is time for
the Private Market to step up to the plate! It is difficult to know
what will happen as we move away from the artificial demand of the Fed
and into the arms of privately-driven markets, where demand for yield
and concerns about fiscal policy and inflation inform investment
decisions. There is a good chance that the same concerns that caused a
flare in rates last year will likely do so again but to what extent is
anyone’s guess. Last week, mortgage rates pushed higher after 2 days
worth of Treasury Bond sales met with poor demand. Here’s a sampling of
where rates sit before rate sheets come out this morning:

30 Year Fixed Rate Conforming Mortgage (1% Origination Fee, and best
credit terms) – 5.000%

30 Year Fixed Rate FHA Mortgage (1% Origination Fee and best credit
terms) – 5.000%

5/1 ARM FHA Product (1% Origination and best credit terms) – 3.875%

Some of the rise in rates this past week might be as a result of several
unknowns to our country’s Fiscal (Dis)Order. Things such as the signing
of the landmark health care reform bill (with unknown costs),
structurally high debt levels, and budget deficits as far as the eye can
see may have profound effects on the economy in years to come and
produce huge (though not yet known) amounts of spending and taxation.
At present, risks are such around the world that US-issued debt is still
considered the safest, but endless commitments to debt service in the
coming years (and the effects of those on economic growth) and worries
about inflating our way out of debt are surely at the forefront of
investor concerns at the moment.

For mortgage investments, the waters get muddier. Normally, an investor
who wanted to buy a mortgage expected three possible outcomes: 1) the
loan would be paid off over the term; 2) the loan would be paid off
early (i.e., refinanced or closed) or 3) the loan would fail, and the
recovery of the committed monies would occur through the process of
foreclosure and disposal of the property. All three outcomes could be
hedged and insured, and losses mitigated or prevented altogether, and a
reasonably knowable or predictable return on the investment could be
proscribed. Not so anymore. Loan modification programs, like the HAMP
program have created a murky limbo for investors. A loan might fail,
with the investor receiving no payments — but now, a known recovery
process no longer exists. A loan might fail, have its terms lengthened,
or changed altogether; the loan’s interest rate might be reduced on a
partial or permanent basis to some new level; even the amount of the
loan which was extended might be subject to a ‘haircut’ — industry
speak for “reduced with no hope of recovery.” What sort of return might
be expected for this investment, and how can one consider, hedge and
insure against loss? You can be sure that investors will want answers
before risking their money.

While we expect some demand for mortgage backed securities to occur as
investors search for yield, we can’t help but wonder: Given the
worsening American fiscal situation, the increasingly-unknowable return
and behavior of a mortgage investment, and that a new financial market
regulatory regime looms large, why would anyone want to make sizable
commitments to invest in mortgages unless the terms under which they
were written were very strict (tight underwriting standards), or the
presence of some form of loss guarantee (FHA-backed loans)?

This is a question we’ll all surely be pondering in the days, weeks and
months ahead.

Although Mortgage rates seem likely to firm this week with the end of
the Fed program remind your clients that historically rates are still
very, very low. Stay tuned for further updates as they occur!

Hugh W. Page, M.B.A.
Sr. Mortgage Consultant, NMLS# 93420
(919) 874-7557 Direct
(919) 595-9707 FAX
hpage@fmlending.com
www.fallsofficeloans.com