FYI | Dec 07 2007
By Greg Peel
He sees you when you’re sleeping. He knows when you’re awake. He knows if you’ve been bad or good so be BAD for goodness sake!
Last night President Bush formally announced his Administration’s initiative aimed at preventing some 1.2 million further mortgage foreclosures in an already distressed US housing market. The initiative does not involve an injection of government funds, but rather gathers together a consortium of banks and mortgage lenders who will agree to freeze the upcoming substantial reset rate jump on adjustable rate mortgages for a full five years.
This will not be a blanket initiative but rather a surgical incision. If you’re an American who has taken on a reset mortgage knowing that it will be a strain on your finances for some time but that you nevertheless will be able to cope, then no bail out for you. In order to be rescued, you must be among the apparent 1.2 million who will have no choice but to default on their loans at the time of reset because they were either too ignorant to understand the mortgage they were getting into or too greedy to care.
While clearly great news for the relevant homeowners, it is also great news for the banks and mortgage originators who lent the money to those homeowners regardless of their financial capacity. It is better to at least receive some capital and interest payments than to be forced into a foreclosure sale which will crystallise a substantial loss. It is also great news for the home builders who carried on erecting vast acreages of Lego-Land homes even as the market was turning and arranging cheap finance for homeowners in order to see those homes sold. Taking 1.2 million homes out of the inventory overhang is a distinct positive. It is also great news for the mortgage insurers who provided cover for banks on mortgages that would never be paid. It is also great news for bond insurers who provided cover for issuers of subprime CDOs that had become worthless.
Everyone’s a winner baby – that’s the truth. Unless, of course, you had taken a bear stance in the free market on the basis of the trouble that the US economy had found itself in. In his statement to the press gallery, President Bush declared that the upcoming spate of mortgage resets posed a threat to the US economy and that lenders and investors faced serious losses. And we can’t have that.
The news came as the US Mortgage Bankers Association announced that foreclosures had hit an all time high. The Fed also announced that US homeowners had lost a record US$128 billion in home equity value in the September quarter. Is that a lot? In 2005 US homeowners gained US$1.2 trillion in value. Boy – now we can really see the extent of the disaster.
The Dow rose 175 points or 1.3% to 13,620 while the S&P rose 1.5% to 1507, breaking up through significant resistance at 1500. The Nasdaq added 1.6%. The bulk of the move came after the Bush press conference. Financials, home builders, insurers and materials were all big winners. But the exuberance spread to all corners including retail and tech.
Across the pond, the Bank of England cut its cash rate from 5.75% to 5.50% last night in response to a falling UK housing market and a weakening UK economy. The European Central Bank kept its rate on hold at 4.00%, however, suggesting the European economy was still relatively strong and inflation was a concern.
The US dollar had a mixed night, rising slightly against the pound (the cut was largely expected), falling slightly against the euro (ditto) and rising against the yen. A lower yen meant a higher Aussie, with the Battler marking a near US1c rally from Wednesday night to US$0.8786. The flight to safety into USA Treasuries lost its validity, so bond yields jumped.
With the subprime bail-out plan in place oil traders were able to stop worrying about a US recession and so the pullback was declared officially over. Crude for January delivery leapt US$2.74 or over 3% to US$90.23/bbl. Without a major rally in the US dollar but with a major rally in oil, gold jumped US$8.00 to US$802.40/oz. So we now have oil back over 90 and gold back over 800.
Base metal markets missed out on the Bush announcement and closed largely weaker. Lead in particular took a big hit down 7%. But tonight will be more telling as markets open with the bail-out in place. If oil is any indication, the veil of gloom should be lifted off all commodities.
The SPI Overnight closed up 55 points.
Market commentators are split down the middle on the rectitude or otherwise of Bush’s bail-out plan. For one thing, the freeze does not alleviate foolish reset mortgage holders of their obligation – it simply pushes it out five years. However, if a US recession can be avoided and the housing crash halted right now then one suspects five years is plenty of time for things to be sorted out.
Free capital markets are never really free anyway. Take, for example, intraday movement limits set in futures markets which shut down a market if a fall is too significant. The idea is that panic is irrational, and a trading halt can allow everyone to calm down. In a similar vein, NYSE traders cannot sell on a down-tick in a stock price once the market has fallen a certain amount in the day. This is a rule put in place as a result of the ’87 crash and tends to pull up a particularly nasty collapse.
One might say that the subprime bail-out is only another example of a similar regulatory initiative, intended to ultimately be for the good of all even if some free market traders are scuppered by artificial interference. Were the US, and maybe the world, to go into recession, is that fair on the little man? Or one might also say that the US government has moved the goal posts mid-game.
Whatever the view, it is most likely that this move, along with further rate cuts from the Fed (and the BoE, and maybe eventually the ECB) will blow away most of the dark and gloomy pall that has hung over Wall Street. Yes Virginia, there is a Santa Claus, and a Christmas rally now looks pretty clear. Tonight’s job numbers will still be material, but somehow they have lost some of their importance.
Will hiding the problem under the rug ultimately put an end to all the problems of the Western world? That remains to be seen. Government sponsored mortgage lender Freddie Mac (which some commentators are prepared to say is actually technically insolvent right now) announced gleefully last night that its fixed 30-year mortgage rate had now fallen to under 6.00% for the first time since 2005.
Let’s do it all again!
