The Week Ahead in the Capital Markets

August 18, 2008

Commodity prices led with a nearly 10% fall in gold, inflation expectations dropped to the lowest in five years, odds for any near-term Fed rate hike disappeared, and Treasury yields fell sharply below 4.00%. Too bad you still can’t get a loan. Spreads of all kinds – mortgage, corporate, muni, LIBOR – widened enough to erase any benefit of the Treasury rally. The spread between mortgage and Treasury yields stands at 2.86%, near the highest levels this year, and 0.50% higher than three months ago.

Dr. Nouriel Roubini, once an obscure professor at NYU, is obscure no more. His gloom and doom prognosis appeared in Barron’s and then in the New York Times. You have to hand to the guy. He was very accurate with his predictions a few years ago. He predicted that the U.S. was likely to face a once-in-a-lifetime housing bust, an oil shock, and a deep recession. He predicted droves of homeowners defaulting on mortgages, trillions of dollars of securities losses, and failures of investment banks, culminating in the breakdown of Fannie Mae and Freddie Mac.

So where does the good doctor think we go from here? First, we’re not headed for a depression. Whew. Although we’ll suffer through a recession that will rank as the “worst since the Great Depression,” it will end with a modest recovery at the end of 2009. Oil will drop below $100 in the coming months. And how to fix the mortgage business? It’s a simple choice, says Roubini. Either the government stands behind a trillion dollars of failing mortgages, or the government props up the banks and other entities holding the mortgages. “You either nationalize the mortgages or nationalize the banks. Otherwise they’re all toast.”

On that note, Barron’s posits that the endgame may be near for Fannie and Freddie. “It is growing increasingly likely that the Treasury will recapitalize Fannie and Freddie in the months ahead on the taxpayer’s dime, availing itself of powers granted it under the new housing bill signed into law last month.” While the agencies are both operating with capital levels above those required by regulators, capital must be raised in the future. The problem is that credit losses are accelerating at an alarming pace, and potential investors in the agencies are fearful that any investment would be eroded quickly. New capital, therefore, is either prohibitively expensive or not available at all. Hence the call for recapitalization by the investor of last resort, the U.S. Treasury.

Meanwhile, the grim housing statistics keep on coming. Zillow reports about the past twelve months: 23.7% of homes sold were sold at a loss. 14.5% of home sales were foreclosures. And 29.1% of homeowners who bought in the past five years have negative equity. Yikes.

Hurricane season is an exciting time to be in Florida. The Weather Channel is busy making two basic meteorological points:
(1) There is no need to panic.
(2) We could all be killed.
There are several key hurricane preparedness items:
HOMEOWNERS’ INSURANCE:  If you own a home, you must have hurricane insurance.   Fortunately, this insurance is cheap and easy to get, as long as your home meets two basic requirements:
(1) It is reasonably well-built, and
(2) It is located in North Dakota
Unfortunately, if your home is located in Florida, or any other area that might actually be hit by a hurricane, most insurance companies would prefer not to sell you hurricane insurance, because then they might be required to pay YOU money, and that is certainly not why they got into the insurance business in the first place.
EVACUATION ROUTE:  If you live in a low-lying area, you should have an evacuation route planned.  (To determine whether you live in a low-lying area, look at your driver’s license; if it says “Florida” you  live in a low-lying area.) The purpose of having an evacuation route is to avoid being trapped in your home when a major storm hits.  Instead, you will be trapped in a gigantic traffic jam several miles from your home, along with two hundred thousand other evacuees. 
HURRICANE SUPPLIES:  If you don’t evacuate, you will need a mess of supplies.  Do not buy them now!  Florida tradition requires that you wait until the last possible minute, then go to the supermarket and get into vicious fights with strangers over who gets the last can of SPAM.  In addition to food and water, you will need the following supplies:

• 23 flashlights
• At least $167 worth of batteries that turn out, when the power goes out, to be the wrong size for the flashlights.
• A 55-gallon drum of underarm deodorant.
• A big knife that you can strap to your leg.  (This will be useless in a hurricane, but it looks cool.)
• A large quantity of raw chicken, to placate the alligators. 
• $35,000 in cash or diamonds so that, after the hurricane passes, you can buy a generator from a man with no discernible teeth.

Thanks for your business and have a good week. – Tom Millon

About Capital Markets Cooperative
Capital Markets Cooperative (CMC) provides mortgage bankers with the economies of scale and the expertise to reduce risk and maximize profit in the secondary market. Regarded as the premiere secondary marketing specialist in the industry, CMC has worked with financial institutions nationwide to break traditional barriers in capital markets and take performance and profits to the next level. To date, CMC executives have managed more than $500 billion of mortgage volume. CMC board members are Tom Millon, Jeff Harry, and Harold Koegler.

For more information about Capital Markets Cooperative, visit www.capmkts.org or call 904.543.0052 or e-mail info@capmkts.org. This e-mail is not a solicitation or investment advice of any kind. You may change your e-mail address, or if this e-mail has reached you in error, or you do not wish to continue receiving it, please let us know by replying to tmillon@capmkts.org.