A horse walks into a bar.  The barman says: “Wait, you can’t come in here without a necktie.”  The horse goes out to his car, looks in the trunk and gets a set of jumper leads, which he ties around his neck.

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He goes back into the bar. “This good enough?” he asks.
Barman says: “Yeh, but you better not start anything.”

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Are you dealing with borrowers with this scenario? They live in a $700,000 house bought with no money down. They can buy an identical house across the street for $500,000. Their FICO’s are >800, flawless. But as soon as they buy the house across the street, they will stop making mortgage payments on their present place. Since their mortgage is non-recourse, and since they don’t need to pay taxes on forgiven debt, the cost of default is basically zero, while the benefit of default is $200,000 ($700-500) in lower total indebtedness. Who loses? The mortgage company, which lent $700,000 to borrowers with good credit and will now have to sell their house, out of foreclosure, for $500,000 for a loss of $300,000 after costs, along with the ultimate investor on the loan. This has nothing to do with “subprime”: everything in this scenario is a prime loan. There are a lot of people who would be more than happy to wreck their prime credit in return for hundreds of thousands of dollars, and credit scores simply don’t appear in the formula “Negative equity + Non-recourse debt = Bad price dynamics and mortgage losses.” This is exactly what was going on in Southern California in the early 90’s.

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What about poor Bank of America? They weren’t buying loans through correspondent channels, and last year eliminated their wholesale/broker channel to focus on retail. Then they decided to buy Countrywide at $18 per share. Countrywide is now in the $4-5 range. Late last summer, Bank of America fired up the market with a $2 billion investment in Countrywide Financial. In exchange for $2 billion, Bank of America secured the right to buy Countrywide stock at $18, a 21% discount over the price at the time. Nobody’s congratulating Bank of America these days, since the value of their holdings is now about $560 million. Now Bank of America faces a tough choice: It can buy Countrywide outright, pour even more money into the lender, or simply bide its time and hope for the best.

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Mortgage prices are a little worse this morning and the yield on the 10-yr is “up” to 3.81%. There is mention in the Wall Street Journal of CitiBank and/or Merrill Lynch seeking more capital to shore up their operations, and that is certainly keeping credit concerns in the headlines. Initial jobless claims for state unemployment insurance benefits fell to a seasonally adjusted 322,000 last week, down 15k from a slightly revised 337,000 the prior week. Economists were expecting a slight increase in new claims to 340,000, and fewer unemployed people than expected is putting some pressure on us although at this time of year it can be difficult to account for seasonal adjustments. Chairman Bernanke will speak on financial markets and the economic outlook, and the market is currently pricing in very high odds that the Fed will cute rates by .50 in two weeks, and so any indication from Bernanke that future rate cuts are not a given will likely create market weakness.

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You know how the auto insurer raises your premium after an accident? Something similar is happening to mortgage fees: they’re becoming more expensive. Many borrowers will see fees that amounts to $250 for every $100,000 borrowed because of the mortgage market. The fees will be tacked onto mortgages guaranteed by Fannie Mae or Freddie Mac, the government-sponsored enterprises that help keep money circulating for home loans. The companies say they introduced the new charges to compensate for the risks inherent in guaranteeing mortgages in an era when house prices are declining, delinquencies are rising and mortgage investors are losing money.

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Rob Chrisman         925-295-9380         rchrisman@rpm-mortgage.com