CAN THE MORTGAGE BUSINESS OPERATE WITH SHORT-TERM RATES AT 5% AND LONG-TERM RATES AT 5%?
A lot of thoughtful people, even on the left, have called for the Fed to be proactive in cutting rates.
Such views seem despairing of whether the "mortgage business" can function with s/t rates at 5% and l/t also at 5%. Historically, the business can function with a flat yield curve. Such conditions probably put more emphasis on analyzing credit, however, because one doesn't get a big financial blanket built from borrowing at 2% to cover your "credit sins", if you make any.
Perhaps the crazy use of FICO scores, that are probably just loose and flawed indicators, is a function of consolidation in the banking industry, perhaps unwanted consolidation, from that perspective.
Here is the case against a rate cut, in detail:
The financial "crisis" may be mostly limited to that.
- Lowering rates is not a great way to restore liquidity, because it incents the kinds of risk taking that created whatever "liquidity crisis".
- If markets have "seized", it is probably more important that weak participants exit or sell off at a loss any debt that they cannot manage further to those who have expertise to do so (workout funds, distressed specialists, etc.) than it is for them to wait for a rate-cut bailout that may not even do the trick.
- There is a strong case to be made that current default levels are simply a return to the longer run averages, than anything else (including a stop on a way to a drastic overshoot).
- There may be reason to believe that "workouts" with individual borrowers, in which they get off of ridiculous-rate ARMs, is enough to contain defaults and keep people from foreclosures.
The tax-code might be used to help as follows: - Some 'workouts' may be able to refinance, using FHA loans or conventional loans with proper mortgage insurance
- For those 'under-water' and in need of a refinance, it is difficult, but it might be possible to allow a supplemental, limited capital tax-loss realization to make a refi in reach at unchanged income levels.
- It is unlikely that the market for prime and near-prime debt will simply dry up. The volumes done by Fannie/Freddie have not trailed off in the months since February, when the crisis started.
- If there is a short-term "crunch" in the market for "jumbos", that's o.k. Once it is clear that defaults are not spiraling here (and they are not), then the market will quickly normalize.
- Now that rates on sub-prime have backed up to the point where people are getting paid for the risk they are taking, the investments are attractive again. This doesn't mean that the CDOs and CP-CDOs are going to find their way back to investment-grade portfolios anytime soon, but these risks will move to the professionals who know how to manage them, ensuring that the market volume doesn't zero-out (it never has for the market in junk corporate debt).
- The US is at or near full-employment, with only a modest slowdown in growth expected.
- There is little question that housing markets will continue to be soft, but if housing prices fall, that is also an increase in housing affordability, other things being equal.
- What's more, a measured slowdown in housing keeps an economy with wartime spending stimulus and full employment from overheating (this is why the markets were shrugging off "bad news" for the first half of the year).
In fact, the principal worry that suggests itself is a steep fall in housing prices, but that just isn't in the current numbers. In markets where prices have leveled off, they are only falling modestly.
The most likely thing that would accelerate a housing price decline would be an accelerating rise in unemployment. That doesn't seem very likely.
