Interest Rates

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<p>SCG,</p>

<p>If you are referring to IHB, I've never seen it censored (aside from spam threads) and I've done my share of censorable posting.</p>
 
<em>Is this board censored?





</em>I know I haven't censored anyone but the spam. I have told people to move on from subjects, but on the forums I have never changed what someone has said, or deleted anything, unless it is spam.





If you posted something, and it didn't show up, then it was a technical glitch, because I can see if a comment has been deleted by one of us mods. And, I don't see one.
 
<p>Darn, ya learn something new every day. It turns out there exists a bond issue called a variable interest entity, (yup, another three letter acronym, VIE). These VIE's are part of the auction rate securities, ARS, market that has been in the news lately and are also some of the issues which are not selling. The interesting aspect of a VIE is that there is a clause in the bond covenant which says that if the issue does not sell, the yield on the bond resets to a predermined rate. And you can bet dollars to donuts that it doesn't reset to a lower yield.</p>

<p>So ... when these VIEs don't sell and their rates reset higher, the municipality or other issuing body has a cow because it can not pay at the new rate. Sound familiar? And if they can not pay at the new rate, their credit rating is affected. Sound familiar?</p>

<p>Oh yah, just some added fodder, guess who sold this VIE structure to the municipalities and made fees and commissions for their generous help?</p>

<p>But, but, but, the underlying asset is still good, right?</p>
 
<p><em>"Is this board censored?"</em>


We also do not permit name calling or strongly negative personal characterizations. </p>

<p>Except on the chat....</p>
 
Current Trend Direction: Reversing lower off the 200-day Moving Average after a morning rally



Risks favor: Very Carefully Floating



Current Price of FNMA 5.5% Bond: $98.22, +78bp and changing rapidly



Is it crazy enough for you? Since the removal of the "up-tick rule" last June by the SEC for stocks - it has been highly volatile for both stocks and bonds...and it's not going away. The last three sessions alone had 100bp swings. In the minutes since I began typing this Daily Update to you, the bond has changed more than it used to in a week.



And currently Mortgage Bonds find themselves a whopping 78bp higher, but have been smacked lower off the 200-day Moving Average ceiling.



Adding to the mix is this mornings Jobs Report - which is the biggest market mover of the month. And The Labor Department reported a loss of 63,000 jobs in February, which was far worse than expectations of 25,000 job creations. Adding further weakness to the report, were downward revisions for both January and February, erasing an additional 46,000 jobs from what was previously reported. So it appears our Jobs Strategy yesterday was accurate, as this negative report has sent Mortgage Bonds soaring higher so far today, but unfortunately only erasing most of yesterday's wild sell-off.



So what happened yesterday? As we all know, only fools think that mortgage rates are based on the 10-year Note--many of them in the media. Yesterday's action simply underscores this fact. History shows us that Mortgage Bonds and the 10-year Treasury Note are only an exact match 1 trading day out of 100. So, watching the 10-year Note for mortgage pricing is the equivalent of using a broken watch to time your appointment.



Yesterday, losses from The Carlyle Capital Group and Thornburg Mortgage decreased their capital to the point where their financial backers had asked for cash back in the way of a "margin call". What does this mean? Imagine a home that received a loan with a 50% LTV...but a provision in the loan stated that under no circumstances could the equity fall below 50%. And the home would need to be appraised every day to evaluate this. If that home lost significant value, the lender would be entitled to an immediate repayment. And when the home actually decreased in value, the lender would make a call for capital to make sure their margin of LTV was intact...a margin call. If the homeowner had the cash to meet this call, all is fine. But if the homeowner did not have the cash, the only way to satisfy the lender would be a sale of the home. And that is what Carlyle Capital Group and Thornburg Mortgage had to do yesterday...they didn't have enough cash to meet their margin call, so they were forced to sell mortgage loans they were holding. This flood of mortgage paper on the market, pushed Mortgage Bond prices lower...much lower. But this didn't have any impact on Treasuries, which were in fact higher on the day. As we have always said, these two securities trade independently.



This morning, the Fed announced additional liquidity through its TAF or Term Auction Facility. This began in December and played a major role in bringing down LIBOR rates, as it added a competitive supplier of short term funds. This helps ARM resets and warehouse lines, but not much help for bonds.
 
<p><a href="http://tinyurl.com/2wg5kc">Mortgage market needs $1 trillion, FBR estimates</a></p>

<p><em><strong>Without that, prices of securities will fall, raising interest rates on home loans</strong></em></p>

<p><em><strong>SAN FRANCISCO (MarketWatch) - Why are interest rates on 30-year fixed-rate mortgages rising even as the Federal Reserve slashes interest rates and yields on Treasury bonds fall?</strong></em></p>

<p><em> The answer is that the mortgage market is short of roughly $1 trillion in capital, according to Paul Miller, an analyst at Friedman, Billings, Ramsey. </em></p>

<p><em> The modern mortgage market works with lots of leverage, or borrowed money. Investors, including hedge funds and mortgage real estate investment trusts, buy mortgage securities, but finance a lot of their purchases with this leverage. </em></p>

<p><em> FBR's Miller estimates that $11 trillion of outstanding U.S. mortgage debt is supported with roughly $587 billion of equity. That's a leverage ratio of 19 to one. </em></p>

<p><em> But last year's subprime meltdown has undermined confidence in the home loans that back these mortgage securities. Now the banks that finance most of these leveraged mortgage investments have started to pull back and impose margin calls, demanding more cash or collateral to back their loans. </em></p>

<p><em> This has sparked a de-leveraging cycle in which some highly leveraged mortgage investors have to sell assets to meet margin calls. Forced selling pushes prices lower, sparking more margin calls, which in turn produces more selling and even lower prices. </em></p>

<p><em> When debt prices fall, yields rise, and that's what's happening to mortgage securities - even those backed by government sponsored entities including Fannie Mae and Freddie Mac which are considered the safest.</em></p>

<p><em> "The immediate impact is that [interest rates on] 30-year fixed-rate mortgages will have to increase relative to Treasuries," FBR's Miller wrote in a note to clients on Friday. "That is why we are experiencing pressure on mortgage rates despite the downward movement on the 10-year bonds." </em></p>

<p><em><strong> Rates on 30-year fixed mortgages usually follow the movement of 10-year Treasury bonds, but this relationship has broken down as de-leveraging in the financial system takes hold.</strong> </em></p>

<p><em><strong> The difference, or spread, between yields on "agency" mortgage securities backed by Fannie and Freddie and those on Treasuries rose to a 23-year high this week, Miller noted.</strong> </em></p>

<p><em>"It is the leverage game playing havoc with the system," he wrote.</em></p>

<p><em> There are two ways to resolve the problem. Either inject $1 trillion of new capital into the mortgage market, or allow prices of mortgage securities to fall (and interest rates on home loans to climb), Miller said. </em></p>

<p><em>The mortgage market won't be able to raise $1 trillion, so prices have to fall, he warned.</em></p>

<p><em> "There is no quick fix here," the analyst said. "It will take about six to 12 months for the pricing pressure to alleviate on these mortgage assets." </em></p>

<em> "This will be painful, but it must be allowed to play out in an orderly fashion in order for the mortgage market to achieve equilibrium," Miller concluded.</em>
 
And for the record. I tend to type lots of short replies. The reason is when I type a whole paragraph, lots of time it will disconnect and I have to re-type the whole darn thing again. Thank you for your understanding.
 
<p>We are in unprecedented times, and I don't think any prior analysis is useful to predict what is going to happen now. Certainly not in detail. The Fed may be wise or inbecilic (my vote is on inbecilic), but you can't predict the future using the past when things are all crazy, like they are now. If ever. </p>

<p>Systemic meltdown. Cascading cross defaults. . .</p>

<p>Who knows what the effect will be on the average person?</p>

<p>All I know is, when I closed loans at 17 1/2%, there was some business, in South Fla. People built little tiny places, because that's all anybody could afford at those rates.</p>

<p>Now the rates are reasonably low, but I don't see ANY closings. So I think those rates are just theoretical. I think for closings to start happening rates have to rise a lot to entice investors back into the mkt. Like (jump all over me) 9, 10, 11%. For good credit. Even more for mediocre. At the rates being offered now, investing is for chumps because everybody knows inflation is back with a bang, and the low inflation postuated by gov't figures has for the past couple of years at least been a lie.</p>

<p>Of course, this means the prices will fall even more. But the money has got to come back and that's the only way to do it.</p>

<p>Also, tho I like a big house as much as the next person, the bottom line is that the whole country has invested too much in real estate, both commercial and residential. We need investment in infrastructure, in research, in education, in manufacturing, not more granite countertops.</p>

<p>There is no more normal. If there ever was.</p>
 
I hear ya lawyerliz. For instance, I read about a lot cities needing to upgrade their sewer and water systems. Pretty mundane stuff, sort of. The big city near me, Nashville, is proposing double-digit water rate increases over the next five years just to cover the capital costs alone. That's some nice infrastructure improvements right there that aren't being funded yet.
 
I do not understand IPOPLAYA's comment that there isn't really much difference between these two options for a buyer: 1) smaller loan + higher mort rate or 2) larger loan + lower mort rate even though both options would have the same P&I per month.



You would always want option 1-- the lower loan amount. You are essentially creating optionality for yourself for getting the lower loan principal despite higher interest rates. First, you have the option to refi if you want at a lower rate in the future. Two, you can pay off the loan quicker if you earn more than the P&I amount each month. Three, you pay lower property taxes and income taxes. Four, your overall obligations are lower despite similar fixed charge per month.



I do not understand why wouldn't you wait until prices reflect the affordability + lower? You can also accumulate $$ by renting in the meantime and create a better a liquidity cushion in this liquidity crisis.



Other than other intangible stuff (pride of home ownership, etc), I simply can not understand why anyone with any common sense would not rather have the smaller loan and higher interest rate.
 
<p>etheran,</p>

<p>From a pure financial perspective you would of course always want a lower loan amount. There are a host of other considerations involved in buying a home, e.g. schools, more space, commute time, etc. etc. </p>

<p>With regards to some of your points:</p>

<p>"First, you have the option to refi if you want at a lower rate in the future"</p>

<p>You are making the assumption that future rates will be lower than they are today... Just like "home prices always goes up" is a fallacy, "you can always refi into a lower rate" could very well be a fallacy as well. We have been at an unprecendented historic low in mortgage rates over the past 5-6 years during the bubble. The massive credit losses lenders and investors are experiencing today could very easily drive mortgage rates back up a more "normal" historical level or maybe even higher. It's is very possible that the average mortgage rate on a 30-year fixed product over the next ten years is 8-9%. </p>

<p>"Two, you can pay off the loan quicker if you earn more than the P&I amount each month"</p>

<p>That makes good sense if you have a high mortgage rate, but if you have a low one, why pay it off early? The after-tax interest you pay on a 6-7% mortgage is 4-5%. One should do just as well, maybe even better considering tax advantages, compounding, etc. investing those dollars in other assets vs. paying down the principal. My mortgage rate right now is 3.875% pre-tax, approximately 2.5% after-tax. Mortgages are a cheap source of funds and you can use that leverage to create additional net worth is you are a smart investor. Personally, I don't want to have all my "eggs in one basket" and would prefer to put more money into the markets if at all possible. It's called diversification and its a basic principle of retirement planning.</p>
 
<em>"That makes good sense if you have a high mortgage rate, but if you have a low one, why pay it off early? "</em>





You have an interesting relationship with debt. Why pay it off early? Peace of mind.
 
<p>Peace of mind is watching my net worth grow. I prefer whatever makes it grow faster within a moderate risk tolerance...</p>
 
Ipoplaya,



That is my point - it is a free option for you as a borrower to refi if rates are lower. A free option is better than no option. I am not saying that rates will trend lower ten years from now - even tho it did today.



You totally missed my point on #2. #2 is another argument to favor a low debt balance/high coupon situation versus a high debt balance/low coupon situation. You always want the lower debt balance anyway you slice it.



I do not care if you choose to repay the mortgage when rates are low - that is a FREE OPTION for me as a borrower -- or simply invest in something else. BUT IF YOU ARE DOING THIS, you are essentially using leverage ..... and you might be forced to UNWIND in the future.



I am looking at this from a borrower perspective and anyway you slice it, one would prefer a lower debt balance than a high debt balance. Who cares about the coupon if your P&I is the same. If you believe your wage earnings will grow you benefit with a lower debt balance. If your wage earnings won't grow, you are screwed either way.



Excluding intangibles (ie., you really like the house), I just do not see why one wouldn't wait until prices are lower one year from now -- who cares if interest rates are higher. If you can buy the same house with the same P&I, you always want to lower debt balance.
 
<p><em>Peace of mind is watching my net worth grow. I prefer whatever makes it grow faster within a moderate risk tolerance...</em></p>

<p>I'm sorry IPO, I'm wracking my brain and for the life of me can't figure out how debt adds to one's net worth.</p>
 
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