Paul Muolo: What’s going on across the Pond

18 January 2010

Reading the tea leaves and trying to predict when the US mortgage and housing markets will return to sustainable health is a fool’s game. But that’s why we have economists - and financial columnists, present company included. So, I’ll ask the obvious - is the US mortgage market on the road to recovery?

The answer depends on your definition of recovery.

It’s no secret that since the autumn of 2008 when credit markets froze not only in the US but worldwide the housing and mortgage industries have been in the tank. In the past 18 months roughly 800 non-bank mortgage lenders and depositories have failed, with about 15,000 broker firms - the small independents that facilitate originations - going bust too. At last check there were about 20,000 brokerages left, down from a high of 60,000 five years ago.

By now we are all well aware of the multibillion dollar losses suffered by US financial institutions on sub-prime and alternative-A - which is basically sub-prime but with higher credit scores - loans and securities.

The $700bn taxpayer bailout of Wall Street is 16 months old and of course Fannie Mae and Freddie Mac, the congressionally chartered mortgage behemoths, are now wards of the federal government. Home prices here continue to fall but at a slower pace and the best that might be said about the current state of the industry is that at least mortgage rates are still at rock bottom levels.

It doesn’t sound promising, does it?

That said, there are a few positives around. First, although mortgage rates have been rising of late there are 30-year fixed rate loans available to
consumers at just over 5%. Amazingly, about four weeks ago some lenders were even offering fixed rate mortgages at 4%.

The best that might be said about the industry is that at least mortgage rates are still at rock bottom levels

So mortgage money over here is cheap but the main problem is the employment situation.

Two key factors drive the US market - rates and jobs. If a consumer has a job he’ll buy a house. It’s as simple as that. If he doesn’t, fill in the blank yourself.

In early January the US unemployment rate remained unchanged at 10% with companies here shedding 85,000 jobs in December. Some economists were looking, if not praying, for a job gain of 100,000. Oh well, dreaming is free, as Debbie Harry once sang.

Meanwhile, the Obama White House insists that its $787bn stimulus package is working, creating and saving jobs. But it doesn’t feel that way, at least not yet.

Getting back to the mortgage picture, low rates do indeed spur home buying and refinancing. For the year just ended mortgage lenders including banks, savings and loans institutions, non-banks and credit unions originated $1.9 trillion in new loans, the third lowest production figure for a decade but a 19% improvement compared with the disaster year of 2008.

Roughly 70% of that total represented the refinancing of existing loans. A government tax credit of $8,000 helped push some first-time buyers off the fence and into the ownership column. The credit, originally set to expire on November 30 2009, was expanded and extended through to spring this year.

In short, conditions are improving slowly on the US mortgage landscape and the best news of all is that low rates have allowed lenders to post their best profit margins in years. It doesn’t take a genius to figure out that when a mortgage banker’s cost of funds is between 1% and 2% lending that money out at 5% results in a huge profit margin. What makes the equation even better for them is that, given all the failures of banks and non-banks the herd has been thinned.

Fewer lenders has translated into less competition. Less competition means mortgage firms can charge more in origination fees without worrying about borrowers running across the street to competitors that have lower prices.

It’s unclear how long profit margins will remain this robust but most mortgage economists believe the situation will not change much this year. That’s the good news. The bad news is that the easy money has already been made on remortgaging - known in the US as refi - and that unless more Americans get back to work soon origination volumes could fall dramatically this year.

Some private estimates range as low as $1 trillion and the Mortgage Bankers Association, the nation’s premier industry grouping, thinks at best loan production will total just $1.3 trillion.

Of course, many other concerns also plague the sector, chief among them the huge market share of the top players Wells Fargo and Bank of America, new capital rules mandating that smaller firms must keep more cash on hand and the fact that 95% of all originations are tied to the existence of Fannie Mae, Freddie Mac and the Federal Housing Administration as either loan investors or guarantors. FHA is the government
mortgage insurance agency.

The origination of sub-prime and alternative-A loans has ground to a halt which means consumers with spotty credit are out of luck unless they can come up with hefty deposits of 20% or more.

As for the home construction picture, conditions are the bleakest they have been for decades.

At best 500,000 homes are likely to be built in the coming year compared with 1.3 million units a few years back. Hundreds of mom and pop
home building firms have closed across the country and it’s no surprise that thousands upon thousands of carpenters, roofers, masons and other tradesmen who made their living on the back of the construction industry are facing an abysmal job outlook.

The only thing that could change all this is a quick snapback in hiring by US employers. Right now, that doesn’t look likely.

• Paul Muolo is executive editor of National Mortgage News

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