The biggest influence on mortgage rates this week came from outside the US. Concerns about the possible default of sovereign debt in smaller nations caused investors to seek the relative safety of US fixed income securities. This week’s economic data was roughly balanced in terms of positive and negative surprises. The added demand for safer investments helped mortgage rates move lower during the week.

 The recession has impacted countries in different ways. Some of the hardest hit have been smaller European nations, such as Greece and Spain. As members of the European Union, they must adhere to certain restrictions which limit their flexibility to adjust domestic economic policy. As a result, some countries may be at risk of defaulting on government debt. Investors responded by buying relatively safer assets such as US bonds, including agency mortgage-backed securities (MBS). Investors also withdrew money from global stock markets during the week. In the US, the Dow fell about 200 points.

 Friday’s important Employment report contained mixed news. Against a consensus forecast for a gain of 15K jobs, the economy lost -20K jobs in January. The big story, though, was an unexpected drop in the Unemployment Rate to 9.7% from 10.0% in December. Two separate sources of data are used to compute the change in jobs and the change in the unemployment rate, and during volatile periods the two methods can show widely divergent results. The decline in the unemployment rate in January was viewed as very good news by many economists, pointing to an improving labor market. On a more negative note, revisions to older data showed that the economy has lost 8.4 million jobs since the start of the recession in December 2007, from the previous reported level of 7.2 million.

At a 50 to 1 leverage ratio, the FHA will soon have a smaller capital cushion than did investment bank Bear Stearns on the eve of its crash. (See nearby table.) Its loan delinquency rate (more than 30 days late in payments) is now above 14%, or from two to three times higher than on conventional mortgages. Its cash reserve ratio has fallen by more than two-thirds in three years.

The reason for this financial deterioration is that FHA is underwriting record numbers of high-risk mortgages. Between 2006 and the end of next year, FHA’s insurance portfolio will have expanded to $1 trillion from $410 billion. Today nearly one in four new mortgages carries an FHA guarantee, up from one in 50 in 2006. Through FHA, the Veterans Administration, Fannie Mae and Freddie Mac, taxpayers now guarantee repayment on more than 80% of all U.S. mortgages. Sources familiar with a new draft HUD report on FHA’s worsening balance sheet tell us that the default rates have risen most rapidly on the most recent loans, i.e., those initiated or refinanced in 2008 and 2009.

All of this means the FHA is making a trillion-dollar housing gamble with taxpayer money as the table stakes. If housing values recover (fingers crossed), default rates will fall and the agency could even make money on its aggressive underwriting. But if housing prices continue their slide in states like Arizona, California, Florida and Nevada—where many FHA borrowers already have negative equity in their homes—taxpayers could face losses of $100 billion or more.

So far Congress has pretended that these liabilities don’t exist because they are technically “off budget.” They stay invisible until they move on-budget when a Fannie Mae-type cash bailout is needed. The Obama Administration is at least finally catching on to these perils and last week proposed some modest reforms. These include appointing a “chief risk officer” at FHA, tightening home appraisals, requiring that FHA lenders have audited financial statements, and increasing the capital requirement of FHA lenders to $1 million up from $250,000. The scandal is that these basic standards weren’t in place years ago.

Unfortunately, Washington won’t touch more significant reforms for fear of angering the powerful nexus of Realtors, mortgage bankers and home builders. As we’ve written for years, the FHA’s main lending problem is that it requires neither lenders nor borrowers to have a sufficient financial stake in mortgage repayment. The FHA’s absurdly low 3.5% down payment policy, in combination with other policies to reduce up-front costs for new homebuyers, means that homebuyers can move into their government-insured home with an equity stake as low as 2.5%. The government’s own housing data prove that low down payments are the single largest predictor of defaults.

Private banks know this. Burned on subprime mortgages, they are back to requiring 10% or even 20% down payments. Congress should at least require a 5% down payment on loans that carry a taxpayer guarantee. If borrowers can’t put at least 5% down, they can’t afford the house.

As for rooting out fraud that contributes to high loss rates, the obvious solution is to drop the 100% guarantee on FHA mortgages. Why not hold banks liable for the first 10% of losses on the housing loans they originate, a reform that has been recommended since as far back as the early Reagan years? No other mortgage insurer insures 100% loan repayment. Alas, while offering its minireforms, the Obama Administration reassured its real-estate pals that FHA insurance will continue to carry “no risk to homeowners or bondholders.”

http://online.wsj.com/article/SB10001424052970204488304574428970233151130.html

Legal snarls, bureaucracy and well-meaning efforts to keep families in their homes are slowing the flow of properties headed toward foreclosure sales, even when borrowers are in deep distress. While that buys time for families to work out their problems, some analysts believe the delays are prolonging the mortgage crisis and creating a growing “shadow” inventory of pent-up supply that will eventually hit the market.

The size of this shadow inventory is a source of concern and debate among real-estate agents and analysts who worry that when the supply is unleashed, it could interrupt the budding housing recovery and ignite a new wave of stress in the housing market.

“There’s going to be a flood [of bank-owned homes] listed for sale at some point,” says John Burns, a real-estate consultant based in Irvine, Calif. When that happens, Mr. Burns believes, home prices will fall further, particularly in markets with large numbers of foreclosures. Overall, he expects home prices to decline 6% next year.

Ivy Zelman, chief executive of Zelman & Associates, a research firm based in Cleveland, believes three million to four million foreclosed homes will be put up for sale in the next few years. The question is whether the flow of these homes onto the market will resemble “a fire hose or a garden hose or a drip,” she says.

Analysts who track the shadow market have focused primarily on the gap between the number of seriously delinquent loans and the number of foreclosed homes for sale by mortgage companies. A loan is considered seriously delinquent, which typically means it is headed to foreclosure, if it is 90 days or more past due.

As of July, mortgage companies hadn’t begun the foreclosure process on 1.2 million loans that were at least 90 days past due, according to estimates prepared for The Wall Street Journal by LPS Applied Analytics, which collects and analyzes mortgage data. An additional 1.5 million seriously delinquent loans were somewhere in the foreclosure process, though the lender hadn’t yet acquired the property. The figures don’t include home-equity loans and other second mortgages

Moreover, there were 217,000 loans in July where the borrower hadn’t made a payment in at least a year but the lender hadn’t begun the foreclosure process. In other words, 17% of home mortgages that are at least 12 months overdue aren’t in foreclosure, up from 8% a year earlier.

Some borrowers may be able to catch up on their payments or receive a loan modification that helps them keep their home. There has also been an increase in short-sales, transactions in which at-risk borrowers sell their homes for less than the loan amount, with the lender’s approval. In some cases, lenders have decided not to foreclose because the home’s value is so low. These factors could mean fewer foreclosures.

Foreclosed homes are partly responsible for the recent increase in home sales. But foreclosures also push down home values. According to Collateral Analytics, a housing research firm, homes that have been foreclosed on typically sell at a 10% to 50% discount.

For now, the delays have led to what is probably a temporary drop in the supply of bank-owned homes in California and other places where investors and first-time home buyers have been competing for bargains. In Orange County, Calif., the number of bank-owned homes listed for sale dropped to 322 in early September from 1,404 in November 2008, according to Altera Real Estate.

But the number of foreclosures is expected to increase in the fourth quarter as mortgage-servicing companies determine who is eligible for a loan modification and who isn’t. “We are going to see a spike from now to the end of the year in foreclosures as we take people out of the running” for a loan modification or other alternatives, says a Bank of America Corp. spokeswoman. Foreclosure sales had dropped to “abnormally low” levels in response to government efforts to stem foreclosures, she adds.

http://finance.yahoo.com/banking-budgeting/article/107799/delayed-foreclosures-stalk-market.html

The Federal Housing Administration said Friday that its financial cushion will sink below mandatory levels for the first time in its 75-year history, but officials insisted the agency won’t need to be rescued.

“Under no circumstance will any taxpayer bailout be needed,” said David Stevens, the FHA’s commissioner. He also said the agency doesn’t expect to raise fees for borrowers, or curtail the number of loans it insures.

Amid the collapse of the subprime lending market, the government has taken up the slack. The FHA has insured nearly a quarter of all new loans made this year, and about 80 percent of that business is from first-time homebuyers.

But the agency has faced mounting concerns on Capitol Hill that it will soon need a taxpayer bailout. As of this summer, about 17 percent of FHA borrowers were at least one payment behind or in foreclosure, compared with 13 percent for all loans, according to the Mortgage Bankers Association.

Plummeting home prices, Stevens said, are the main reason its financial reserves are dwindling. While an earlier analysis had assumed prices would hit bottom this year, the agency now is assuming prices will fall through next spring.

“While FHA didn’t take part in the housing boom, it’s not immune from the ripple effect of declining house prices,” said Brian Montgomery, the agency’s former commissioner. “That’s quite frankly what this is about.”

The agency itself does not make loans, but rather offers insurance against default. Many borrowers are willing to pay for the insurance because FHA loans only require down payments of 3.5 percent of the purchase price.

The FHA now insures about 5.3 million mortgages, up from about 4 million three years ago.

In an effort to weed out shady operators, it wants to require that participating lenders have a net worth of $1 million, up from the current requirement of $250,000, and undergo annual audits.

Last month, FHA banned mortgage company Taylor, Bean & Whitaker from making any more federally insured loans after it failed to submit a required financial report, raising fraud concerns.

FHA officials have long pushed in Congress for more money to upgrade the agency’s outdated computer systems and say they are stepping up the agency’s efforts to catch shady operators who funnel bad loans.

But Bert Ely, a banking industry analyst in Alexandria, Va., said he wouldn’t be surprised if the FHA asks for a taxpayer bailout in the coming years. Though, he said, it’s likely to be far smaller than the $96 billion that mortgage companies Fannie Mae and Freddie Mac have tapped since they were seized by federal regulators a year ago.

http://finance.yahoo.com/news/Govt-home-loan-agency-faces-apf-2908284556.html?x=0&sec=topStories&pos=3&asset=&ccode=

Congress has impaneled a “bipartisan” commission to get to the bottom of the subprime scandal. Will it? Only if it listens to a panelist who predicted the disaster.

That panelist — one of 10 making up the newly formed Financial Crisis Inquiry Commission — is former Reagan Treasury official Peter Wallison. He first sounded alarms in 1999, as Fannie Mae began easing credit rules to please the Clinton administration, which accused it of racial discrimination.

Under mounting political pressure, the mortgage giant took on riskier loans in underserved — mostly minority — communities. Wallison warned that those loans could turn bad if the economy turned south, triggering a government bailout similar to that of the S&L rescue.

“This is another thrift industry growing up around us,” Wallison told the New York Times. He gave the interview in September 1999 as a resident fellow at the American Enterprise Institute. “If they fail,” he added, referring to Fannie Mae, “the government will have to step up and bail them out the way it bailed out the thrift industry.”

His prescience was limited only in underestimating the damage, as this bailout will, in the final analysis, dwarf the S&L bailout.

Today Wallison isn’t getting the credit he deserves because he doesn’t toe the conventional line regarding the root causes of the debacle. He doesn’t blame unscrupulous mortgage brokers. Or greedy investment bankers. Or incompetent rating agencies. Or foolish investors. Or whiz-kid investors of complex derivatives.

Instead, he blames Washington for encouraging all of them to do what they did. Government policy, he says, manipulated “the credit system to force more lending in support of affordable housing.”

This crisis wasn’t a failure of capitalism, Wallison argues. It was a failure of government.

“The crisis would not have become so extensive and intractable,” he recently said, “had the U.S. government not created the necessary conditions for a housing boom by “directing investments into the housing sector , requiring banks to make mortgage loans they otherwise would never have made , requiring Fannie Mae and Freddie Mac to purchase the secondary mortgage market loans they would never otherwise have bought and encouraging underwriting standards for housing that were lower than for any other area of the economy.”

An early critic of the Community Reinvestment Act, a banking rule that socializes mortgages, Wallison argues too much regulation caused the mortgage meltdown.

As we’ve detailed on these pages, President Clinton strengthened the CRA (by requiring, for the first time, numerical quotas for affirmative lending) and used it to pressure banks into making risky loans and to adopt “flexible” lending standards.

http://www.investors.com/NewsAndAnalysis/Article.aspx?id=505924

The future structure of mortgage lenders Fannie Mae and Freddie Mac lies in the hands of Congress and to help guide lawmakers, a government watchdog group issued an analysis of options on Thursday.

The U.S. Government Accountability Office found that the two government-sponsored enterprises have a mixed record in meeting their mission to foster affordable housing, and that both capital and risk management deficiencies had compromised their safety and soundness.

The GAO analysis examined a series of options that could be considered for Fannie and Freddie , which last year were seized by regulators worried the companies were near collapse.

Following are some scenarios, gleaned from comments by policy-makers, analysts and the GAO report, for the two mortgage lending giants.

 FULL NATIONALIZATION

This might be the easiest option and would return the companies to their origins as a government tool to nurture the housing market.

Shareholders have had a stake in Fannie Mae ( FNM – news - people ) and Freddie Mac ( FRE – news - people ) only for about 40 years. Before that, the companies were fully owned and guaranteed by Washington.

Under the current conservatorship, Fannie Mae and Freddie Mac are effectively in government hands again. Policy-makers may choose to hold that status quo and formally eliminate investors’ interest in the companies.

The government could decide to have the two so-called GSEs focus on buying qualifying mortgages and issuing mortgage-backed securities, and not allow them to hold mortgage debt in their own portfolios. The Federal Housing Administration, which insures mortgages for low-income and first-time borrowers, could assume more responsibility for promoting homeownership for targeted groups.

 

PRIVATIZATION WITH PAYMENT FOR INSURANCE

Policy-makers might return the companies to investors and offer to insure Fannie Mae and Freddie Mac investments.

Washington could charge the companies a fee to underwrite their debt and some of their mortgage securities as a way to nurture the housing finance sector without standing squarely behind the companies. This idea, aired by Federal Reserve Chairman Ben Bernanke, would be akin to the Federal Deposit Insurance Corporation’s protection of banks.

 

COOPERATIVES WITH LOOSE GOVERNMENT TIES

Fannie Mae and Freddie Mac could be run by the companies that sell them home loans. In such a cooperative arrangement, Fannie and Freddie would focus on long-term, stable business rather than maximizing profits. The federal government might still offer to insure the companies against the most catastrophic losses. This arrangement could be akin to the Federal Home Loan Bank system where a dozen regional lenders are jointly and severally liable for any one member’s losses and the federal government acts as guarantor of the entire system.

 

UTILITIES MODEL

Just like power and water companies that provide vital services, Fannie Mae and Freddie Mac could be run as private entities that have strong government oversight. The companies would aim to turn a profit and would have no government backing, but a conservative board would set earnings payments and customer fees.

 

PRIVATE MORTGAGE-FINANCE COMPANIES

Although Fannie and Freddie are in government hands, their regulator is still trying to keep their shares trading. The agencies could emerge as large mortgage finance companies that bundle home loans for investors and raise funds in the traditional capital markets. Without government ties, though, the companies would not have lower funding costs and so would not enjoy the competitive advantage they do now. The federal government would also lose one of its most powerful tools for helping low-income home buyers.

GAO said privatizing or terminating Fannie Mae and Freddie Mac would disperse mortgage lending and risk management through the private sector.

 

COVERED BONDS

While they are currently only a talking point on Wall Street, covered bonds could become a mortgage finance tool to rival the influence of Fannie Mae and Freddie Mac. Unlike traditional mortgage-backed securities, which are frozen blocks of home loans, covered bonds allow banks to manage a dynamic pool of mortgages. This financing tool is popular in Europe but has a weak foothold in the United States because of regulatory constraints and the competitive advantages of Fannie Mae and Freddie Mac. The fate of those companies will have a direct impact on the future of covered bonds.

http://www.forbes.com/feeds/afx/2009/09/10/afx6872313.html

The Federal Housing Administration, hit by increasing mortgage-related losses, is in danger of seeing its reserves fall below the level demanded by Congress, according to government officials, in a development that could raise concerns about whether the agency needs a taxpayer bailout.

The rising losses at the FHA, part of the U.S. Department of Housing and Urban Development, come as the agency has rapidly increased its role in guaranteeing loans in an attempt to stabilize the housing market.

It isn’t clear how the rising losses may affect home buyers. Options for the agency could include politically unpalatable choices, such as asking for taxpayer funds to boost reserves or increasing the premiums borrowers pay for the insurance offered by the agency. Agency officials say if there is a shortfall, they don’t have to do anything except report it to lawmakers. But some mortgage and housing analysts see trouble ahead. “They’re probably going to need a bailout at some point because they’re making loans in a riskier environment,” says Edward Pinto, a mortgage-industry consultant and former chief credit officer at Fannie Mae. “…I’ve never seen an entity successfully outrun a situation like this.”

The FHA insures private lenders against defaults on certain home mortgages, an inducement to make such loans. Insurance from the New Deal-era agency has enabled lending to buyers who can’t make a big down payment or who want to refinance but have little equity. Most private lenders have sharply curtailed credit to those borrowers.

In the past two years, the number of loans insured by the FHA has soared and its market share reached 23% in the second quarter, up from 2.7% in 2006, according to Inside Mortgage Finance. FHA-backed loans outstanding totaled $429 billion in fiscal 2008, a number projected to hit $627 billion this year.

Rising defaults have eaten through the FHA’s cushion. Some 7.8% of FHA loans at the end of the second quarter were 90 days late or more, or in foreclosure, according to the Mortgage Bankers Association, a figure roughly equal to the national average for all loans. That is up from 5.4% a year ago.

Resulting FHA losses are offset by premiums paid by borrowers. Federal law says the FHA must maintain, after expected losses, reserves equal to at least 2% of the loans insured by the agency. The ratio last year was around 3%, down from 6.4% in 2007.

If its reserves fall short, the agency is obliged to notify Congress, which could spark a commotion over the extent to which the government is funding losses in the housing market. Some housing analysts have said losses might lead the FHA to pull back lending, which has helped boost flagging housing demand.

http://online.wsj.com/article/SB125202440174685297.html

Amid continued concerns over fraud and misrepresentation in the mortgage industry, Fannie Mae has tightened its compliance rules. Updated Fannie Mae policies regarding the use of IRS Forms 4506, 4506-T, and 8821 to validate borrower income documentation go into effect September 1, 2009. Lenders who fail to comply with the new policies run a high risk of failing to meet all of Fannie’s updated underwriting guidelines and, as a result, will be unable to sell their loans to Fannie Mae.

Beginning September 1, Fannie Mae will require all lenders to:
    –  Obtain from the borrower(s) a completed and signed Form 4506-T at both
        loan application and closing
    –  Add the execution of Form 4506-T with the IRS (or designee) to the
        lender’s written quality control plan

    –  Ensure that all loans selected for quality control review include the
        reconciliation of the tax transcript information with the income
        documents in the loan file

“The 4506-T policy change from Fannie Mae has been the subject of much debate since the June 2009 announcement,” stated Will Dillard, Director of Operations at SettlementOne Credit Corporation. “While some have interpreted the announcement to mean that Fannie Mae only ‘highly recommends’ that transcripts are obtained from the IRS, the requirement states definitively that lenders must add the execution of the Form 4506-T with the IRS to their written quality control plan. Fannie Mae then goes on to further require that the reconciliation of the transcript information with the income documents in the loan file must be completed for all loans selected for the lender’s quality control reviews.”

Even the most responsible borrowers slip up sometimes. Maybe a utility bill went unpaid after you moved and the missed payment went into collections. Or, perhaps there are unpaid library fines or parking tickets in collections that are hanging onto your credit history and affecting your FICO credit score, which is widely used by lenders to evaluate your ability to repay a debt. With the newest version of the FICO credit-scoring system, however, minor delinquencies are now overlooked in calculating creditworthiness. Under the updated scoring model, called FICO 08, small, missed payments lingering in collections with original amounts of $100 or less will no longer do damage to your credit score. Consumers also are less likely to be penalized for any single delinquency if it occurred two or more years ago—and if their credit history is otherwise unblemished, says FICO, formerly Fair Isaac Corp., which developed the FICO scoring system.

“There’s more flexibility with missing a payment,” said Careen Foster, director of global scoring product management for FICO. “If you have a more habitual pattern of paying accounts late, you’re more likely to get penalized for that.” If a consumer’s credit usage is high, that will be more likely to hurt his or her score with FICO 08. But getting close to your credit-card limits—even if you always pay on time—is penalized in some way in every FICO score, not only the recent edition, Foster said.

The new system has been available at all three credit bureaus—Experian, TransUnion and Equifax—since last month. The changes were made to provide lenders with a better risk assessment of borrowers, said John Ulzheimer, president of consumer education for Credit.com, a consumer education and advocacy site. FICO decided that one small library fine didn’t really predict whether a consumer was likely to default, for example.

With the changes, individuals who pose a low credit risk will probably see their scores rise a bit, and those who are high risk could see their scores drop, he adds.

FICO 08 also addresses “piggybacking,” a practice used by credit-repair companies to help people improve their scores, Ulzheimer said. In piggybacking, an individual pays to become an authorized user on a stranger’s account. The account holder gets paid for allowing the person to be associated with the account, and the new authorized user is able to improve his or her credit score.

“It was a practice to misrepresent what your credit looks like to your bank,” Foster said. FICO 08 aims to single out individuals who are named as authorized sources through deceptive means, Ulzheimer said. Those people won’t see their credit scores rise as a result. But the scores of legitimate authorized users will be treated as they always have been.

Borrowers shouldn’t expect their credit to be graded by this new scale on every loan they now apply for. Not all lenders have adopted the new model, though more than 400 lenders are using or testing FICO 08, the company said. In a statement, Equifax said, “Currently, many lenders and businesses are validating the new score within their systems, and adoption will vary by financial institution based on business requirements and market need.”

Many credit-card companies, auto lenders, regional banks and credit unions may have already adopted FICO 08, Ulzheimer said. But for mortgages, lenders doing traditional conforming loans backed by Freddie Mac and Fannie Mae likely haven’t made the move yet, he said. That’s because they’re waiting for Freddie and Fannie to approve its use. Freddie Mac and Fannie Mae “are essentially the lender, they’re the ones that set the underwriting criteria,” he said. Ulzheimer said he expects Freddie and Fannie to adopt FICO 08 by the end of the year. Fannie declined to comment on FICO 08; Freddie wasn’t able to provide a comment prior to publication.

While FICO 08 will help consumers’ credit scores in some cases, people still should take steps to improve their credit. Granted, it’s impossible for consumers to calculate their FICO scores themselves, said Rodney Anderson, of Rodney Anderson Lending Services in Plano, Texas. “It’s almost like the Coca-Cola formula. No one has access to the Coca-Cola formula, no one has access to the FICO formula,” he said. But by being proactive, you can start to work toward a higher score, something that will serve you well every time you apply for a loan.

Some suggestions for improving your credit score:

-Monitor your credit reports and correct errors. Look not only for negative events on your record, but also examine the credit limits to make sure they’re accurate. If the credit limits appear lower on the report than they actually are, that has the potential to hurt your score.

-Pay bills on time and keep card balances low. Your payment history, and the amount you owe on your accounts as a ratio of the amount of credit you have access to, are important components of your score. FICO 08 is more sensitive to high credit usage, and consumers may see a lower score if their reported balance on one or more cards is near the account’s limit.

-Take on new credit only when you need it. Some credit cards come with great offers, including a percentage off your bill if you sign up for one at the cash register. If you accept, make sure you’re getting a big enough benefit to make it worthwhile—taking on additional credit could end up dinging your score.

Read more: http://rismedia.com/2009-08-31/new-credit-scoring-model-may-boost-some-borrowers-scores/#ixzz0Pt5bu4W2

Favorable repricing took place yesterday.

•  The 30-yr fixed FNMA required net yield (60 day) is now at 4.89%, from 4.93% yesterday.
• It has been a quiet morning so far ahead of today’s economic data.
• The Dow is up 25 points.
• The ISM index, Pending Home Sales, and Construction Spending will be released at 10:00 et.