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Frank Nothaft, Freddie Mac's VP and chief economist, was the keynote speaker at the 2008 Five Star Conference's State of the Industry Luncheon. Nothaft gave attendees his economic outlook for the remainder of the year and into 2009, focusing on the housing and mortgage markets.

Nothaft warned that we are not at the “trough” of the current crisis yet, but that we are getting close. “The housing contraction has still a bit further to go,” Notaft said, noting that recession risks are still highly elevated and credit quality is continuing to deteriorate. All in all, Nothaft said, we can expect slowed growth for the balance of this year.

We are starting to see a recovery in housing starts and existing home sales, Nothaft said. But, he cautioned, nationally home prices are still receding and are expected to continue an overall decline into 2009.

As we have consistently seen over last year and half, quarter after quarter, Nothaft said, creditors across the lending community – primary and secondary – are tightening their lending standards and criteria for all lines of business. Because of recent turmoil and institution shake-ups, Nothaft warned, we can expect banks to become even more cautious with lending standards, without any sign of letting up anytime soon. With that in mind, Nothaft said to expect the lending crunch to continue through 2009.

Nothaft did note a few hopeful market signs. Over the past year or so, he said, mortgage rates have consistently climbed upward, but within just the last month, we have begun to see them drop. A drop in mortgage rates will significantly help with the housing market's recovery, said Nothaft.

Another bit of good news for lenders, Nothaft said, is that Freddie Mac and Fannie Mae have and will continue to make sure that there is credit readily available. In the past year and a half, Nothaft explained, we've seen a dramatic shift in the financing of mortgage loans. While private-label mortgage backed securities (MBS) virtually disappeared as the subprime crisis hit and defaults began to soar, Nothaft said, security issuance by Freddie and Fannie has remained steady, and will continue.

Single-family home building hit a record high in 2005, but fell more than 60% since then – the biggest crash in U.S. history, Nothaft said. Likewise, existing home sales are down sharply since the 2005 home building peak, he added.

What this has left us with, Nothaft said, is a large inventory overhang in most regional markets, primarily the result of 2005-2006 over-building. “We've got about a three million inventory surplus now,” Nothaft said. In normal market conditions, that number is two million, Nothaft explained, so we've got about a million excess in terms of the number of houses on the market. Housing markets are not going to improve until we work down that excess inventory, Nothaft said.

For this reason, Nothaft said he does not expect a national recovery in home prices until 2010. House price declines have been widespread and severe in some large markets from the second quarter of 2007 to the second quarter of 2008.There are regional, local markets that might have appreciation, but the national metric will continue to decline through 2009, Nothaft said. In addition, Nothaft noted, the time a home is on the market has risen dramatically in most metro areas.

Nothaft said though, that he does expect mortgage originations to pick up over the next year. In fact, he said, lower mortgage rates in just the last month have already begun to trigger increased activity.

Nothaft also said that he expects mortgage sector job losses for 2008. He noted that about 150,000 jobs have been lost in the mortgage business just over the past two years.

Nothaft concluded, “We still have some bad news ahead of us – more foreclosure and more defaults. It's going to get worse before it gets better.” Nothaft added though, that by the latter part of next year, he expects we'll start to see definitive signs of a modest recovery.

HOW'S THE FAMILY?

OK, sure - you prepare the meals, maintain the yard, balance the checkbook, take the kids to soccer, wash and iron the clothes, tune-up the car. You take care of all the daily needs of the family. So - is that your contribution to them, or a contribution to your commitment to them?

Our world today is frantic. As adults, our responsibilities are awesome. Our careers require long and odd hours away from family. Our children are lured by television towards needs and desires for more and more material possessions, i.e. logo clothing, "gaming" accessories, makeup, or cool vehicles. Our spouse wonders why there's never enough time for "us." Where will it all end? How can we slow down?

If your family is moving at the speed of life, and there seems to be no end in sight, maybe it's time to take a look at your commitment to all involved. A great place to start is time alone with your spouse - away from home. If possible, that means an overnight or weekend trip. It's a time to re-examine your values, your goals in life, and the direction you would like your family to take. Finally, it's a time to re-commit to the health of your marriage.

You may quickly realize that it's a time to simplify your life - and that of your family. That's easy to say - more difficult to accomplish - yet attainable with a firm commitment. If you like the idea of simplification, there are three excellent books that can move you in that direction.

First is a great primer, Anne Morrow Lindbergh's "Gift From The Sea." Next, for both men and women is "The Simplicity Reader" by Elaine St. James. Finally, and especially for women, is "Simple Abundance" by Sarah Ban Breathnach. Why not make a new commitment to your family, beginning today? Your contributions will be much more enjoyable!

The Top Ten Things To do This Weekend

http://www.sun-sentinel.com/entertainment/sfl-weekend-guide,0,3810632.photogallery

1. Crandon Park Beach
4000 Crandon Boulevard, Key Biscayne; 305-361-5421.

Take the Rickenbacker Causeway to Key Biscayne. Crandon Beach Park, a former coconut plantation on Key Biscayne, is consistently named among the Top 10 beaches in the nation. There are more than two miles of "lagoon-style" beach, with calm water protected by a constantly shifting offshore sandbar.

Media reports are suggesting Thursday morning that Morgan Stanley (MS: 27.21 +20.67%) — one of only two independent investment banks left standing — has begun the process of finding a merger partner. Whispers about the future of both Morgan Stanley and fellow independent i-bank Goldman Sachs (GS: 129.80 +20.19%) have grown much louder in the back half of this week, in the wake of the failure of Lehman Brothers Holdings Inc. (LEH: 0.00 N/A) on Monday.

Perhaps the most telling report was filed late Wednesday by the New York Times, which ran a quote allegedly from Morgan Stanley CEO John Mack, before retracting the quote a few hours later. “We need a merger partner or we’re not going to make it,” the paper quoted him as telling Citigroup Inc. (C: 20.65 +24.02%) CEO Vikram Pandit; Citi, for what it’s worth, appears to have shunned any deal involving the ailing investment bank.

(The Times later retracted the quote, a rare move for the publication, as both Citi and Morgan Stanley vigorously denied the remarks ever being made; the Times sources originally responsible for providing the quote also could not verify that Mack actually said the words in question.)

Various key sources on the Street have told HW that Mack is “much more pragmatic than [Lehman CEO Richard] Fuld,” and that he would look to find a deal before the clock runs out on his firm. And deal searching he appears to be, with various reports suggesting that Morgan Stanley has approached Citi and Wachovia Corp. (WB: 18.75 +29.31%) about a possible merger in the past few days.

The Wall Street Journal pulled out a laundry list of potential global deal partners Thursday morning, including HSBC Holdings PLC, Banco Santander SA, Nomura Holdings Inc., and even Bank of New York Mellon Corp. — essentially, any commercial banking operation that hasn’t been entirely wiped out by the current credit debacle. The paper said the names of potential suitors came from sources near Morgan Stanley.

“Right now, it’s a game of musical chairs,” said one source, who asked not to be named in this story. “The fear at Morgan Stanley is that by waiting, Goldman may get the prize. Nobody wants to be out in the cold when the music stops here.”

Indeed, such speculation about Goldman has been growing as well, although very little has leaked to the press regarding the investment bank’s intentions. The Wall Street Journal’s Heard on the Street column noted on Thursday that “Goldman could be left exposed” should Morgan Stanley choose to merge with a commercial banking operation.

A merger with Wachovia, however, may prove to be problematic. The bank faces its own mortgage-led troubles surrounding an ill-fated purchase of option ARM specialist Golden West Financial in 2005; option ARMs constitute $122.2 billion of the bank’s $488.2 billion in total loans. No other U.S. bank has as much exposure to option ARMs in real-dollar terms.

CEO Robert Steel said last week in an investor presentation that 66 percent of borrowers in its option ARM portfolio have some deferred interest balance, which has driven $3.9 billion in paper income for the bank. The current average loan-to-value ratio of its entire option ARM portfolio is now up to 90 percent — and that’s an estimate that is based on May 2008 data, meaning it’s already four months old. It’s a safe bet that the average LTV is now well over 90 percent.

Nonetheless, CNBC’s Charlie Gasparino reported on Thursday morning that Morgan Stanley is in advanced discussions with Wachovia and will begin formal merger negotiations sometime before the end of today.

Shares in Morgan Stanley were at $21.21, off 2.5 percent, when this story was published; the firm’s shares fell despite a broader rebound in the Dow Jones Industrials, which were up 175.95 points in early trading Thursday.

While Freddie Mac (FRE: 0.55 +66.67%) reported Thursday that mortgage rates had fallen by 15 basis points to an average of 5.78 percent for a conforming 30-year fixed-rate mortgage during the week ended Sept. 18, rates have been anything but stable this week, according to HW’s market sources. The Freddie Mac-reported rate is the lowest since February, but it may not remain there for long if financial markets continue to convulse.

Rates have jumped sharply in recent days, according to a story filed Thursday at the Wall Street Journal — not exactly the outcome most had in mind when the Treasury put both GSEs into conservatorship two weeks back.

According to the Journal, which cited data from HSH Associates, conforming 30-year-fixed mortgage rates now average 6.11 percent, a full 33 basis points above the numbers reported by Freddie Mac. The Journal cited unnamed brokers in suggesting that rates have risen “one-eighth to one-quarter of a percentage point in the past two days.”

The Freddie data suggested that rates on adjustable-rate mortgages slid this week as well, with five-year Treasury-indexed hybrid ARMs falling from 5.87 percent to 5.67 percent; likewise, the average rate on one-year ARMs dropped 18 basis points to 5.03 percent. Such steep drops in ARM rates likely reflect a “flight to quality” by investors in the wake of Lehman’s bankrtupcy and Merrill’s sellout; investors had flooded Treasuries in recent days — the result has been lower yields on Treasuries as prices were bid upward, a trend that reversed on Thursday as investors returned to equities.

That said, the relationship most originators associate between Treasuries and mortgage rates has been more tenuous than ever this year, something the Journal noted; its coverage quoted Mahesh Swaminathan, a mortgage strategist at Credit Suisse Group (CS: 50.17 +3.94%), as saying the spread between mortgages and Treasuries had risen by 35 basis points in the past week amid market convulsions.

One of HW’s sources said the spread had widened by 47 basis points between the government’s takeover of the GSEs to yesterday’s close.

Conforming mortgage rates are only part of the mortgage picture, of course; and for jumbo borrowers — those looking to buy a property outside of the conforming loan limits — rates have soared. Rates currently average 7.42 percent for 30-year fixed-rate jumbo mortgages, according to HSH data.

Adding to the problem is the effect of a planned sale by Merrill Lynch & Co. (MER: 29.50 +33.73%) and the bankruptcy of Lehman Brothers Holdings Inc. (LEH: 0.00 N/A), both of whom were large players in the secondary mortgage market. A source told HW on Thursday that there is essentially no mortgage repo market at present, as a result of recent market upheaval. “That is a serious problem,” said the source.

“The [mortgage spread] widening is definitely linked to the lack of any bids in the roll,” said the source, an ABS/MBS analyst that asked not to be named. “With no bid, it forces people to take delivery, forcing dealers who haven’t a lot of capital to spare to take delivery.”

The repurchase, or repo market, is critical to modern financial markets because it provides banks with the ability to fund their own operations.

(Explanatory note: in a repo trade, fixed-income securities are lent out for cash over short periods of time; the mortgage market’s giant TBA market utilizes a type of repo known as a dollar roll. Rolls have some key differences from traditional repos, but we won’t discuss that here; it should be enough to just note that a whole lot of MBS trades are financed this way).

Bottom line: what really caused the failure of Bear Stearns, for example, wasn’t the stock price drop per se. It was that Bear suddenly found itself locked out of the repo market. It’s why the Fed began the Term Securities Lending Facility, with the hopes of at least providing some temporary funding to ailing investment banks; clearly, the TSLF didn’t provide much help to Lehman.

The simple fact is that the complex troubles now being observed within the secondary mortgage market will be felt in mortgage rates borrowers see going forward. If we see rates continue to jump around in the weeks ahead, you’d need look no further for a reason why.

While Freddie Mac (FRE: 0.55 +66.67%) reported Thursday that mortgage rates had fallen by 15 basis points to an average of 5.78 percent for a conforming 30-year fixed-rate mortgage during the week ended Sept. 18, rates have been anything but stable this week, according to HW’s market sources. The Freddie Mac-reported rate is the lowest since February, but it may not remain there for long if financial markets continue to convulse.

Rates have jumped sharply in recent days, according to a story filed Thursday at the Wall Street Journal — not exactly the outcome most had in mind when the Treasury put both GSEs into conservatorship two weeks back.

According to the Journal, which cited data from HSH Associates, conforming 30-year-fixed mortgage rates now average 6.11 percent, a full 33 basis points above the numbers reported by Freddie Mac. The Journal cited unnamed brokers in suggesting that rates have risen “one-eighth to one-quarter of a percentage point in the past two days.”

The Freddie data suggested that rates on adjustable-rate mortgages slid this week as well, with five-year Treasury-indexed hybrid ARMs falling from 5.87 percent to 5.67 percent; likewise, the average rate on one-year ARMs dropped 18 basis points to 5.03 percent. Such steep drops in ARM rates likely reflect a “flight to quality” by investors in the wake of Lehman’s bankrtupcy and Merrill’s sellout; investors had flooded Treasuries in recent days — the result has been lower yields on Treasuries as prices were bid upward, a trend that reversed on Thursday as investors returned to equities.

That said, the relationship most originators associate between Treasuries and mortgage rates has been more tenuous than ever this year, something the Journal noted; its coverage quoted Mahesh Swaminathan, a mortgage strategist at Credit Suisse Group (CS: 50.17 +3.94%), as saying the spread between mortgages and Treasuries had risen by 35 basis points in the past week amid market convulsions.

One of HW’s sources said the spread had widened by 47 basis points between the government’s takeover of the GSEs to yesterday’s close.

Conforming mortgage rates are only part of the mortgage picture, of course; and for jumbo borrowers — those looking to buy a property outside of the conforming loan limits — rates have soared. Rates currently average 7.42 percent for 30-year fixed-rate jumbo mortgages, according to HSH data.

Adding to the problem is the effect of a planned sale by Merrill Lynch & Co. (MER: 29.50 +33.73%) and the bankruptcy of Lehman Brothers Holdings Inc. (LEH: 0.00 N/A), both of whom were large players in the secondary mortgage market. A source told HW on Thursday that there is essentially no mortgage repo market at present, as a result of recent market upheaval. “That is a serious problem,” said the source.

“The [mortgage spread] widening is definitely linked to the lack of any bids in the roll,” said the source, an ABS/MBS analyst that asked not to be named. “With no bid, it forces people to take delivery, forcing dealers who haven’t a lot of capital to spare to take delivery.”

The repurchase, or repo market, is critical to modern financial markets because it provides banks with the ability to fund their own operations.

(Explanatory note: in a repo trade, fixed-income securities are lent out for cash over short periods of time; the mortgage market’s giant TBA market utilizes a type of repo known as a dollar roll. Rolls have some key differences from traditional repos, but we won’t discuss that here; it should be enough to just note that a whole lot of MBS trades are financed this way).

Bottom line: what really caused the failure of Bear Stearns, for example, wasn’t the stock price drop per se. It was that Bear suddenly found itself locked out of the repo market. It’s why the Fed began the Term Securities Lending Facility, with the hopes of at least providing some temporary funding to ailing investment banks; clearly, the TSLF didn’t provide much help to Lehman.

The simple fact is that the complex troubles now being observed within the secondary mortgage market will be felt in mortgage rates borrowers see going forward. If we see rates continue to jump around in the weeks ahead, you’d need look no further for a reason why.

The mortgage REIT sector was not exempt from the financial crisis that swept Wall Street this week. Shares of nearly every mREIT tanked on Wednesday in response to fears that the investment bank meltdown could ratchet up counterparty risk and reduce vital access to liquidity.

However, these losses were largely recouped on Thursday, when the market staged a dramatic turnaround in the wake of a Treasury plan to resolve the bad debt crisis in the banking system. In all, shares swung wildly throughout week, with double-digit percentage gains or losses were common across the board. (The rallies didn’t extend to every group, though.)

Another angle to the meltdown was the concern that consolidation of the investment banks would lead to a glut of available commercial real estate in the New York City area. As a result, commercial mREITs with a concentration of business in NYC, like iStar Financial (SFI: 5.25 +5.00%) and Gramercy Capital (GKK: 5.20 +17.12%) were hit the hardest. Both companies notched new 52-week lows this week, although they regained most of their losses in early morning trading on Friday.

Everybody Loves Hatteras
The market may not be sure which way to head, but the analysts lined up behind Hatteras Financial (HTS: 21.52 -1.47%) this week. Analyst Bose George at Keefe Bruyette & Woods reiterated his outperform rating on the stock, saying that Hatteras’ exposure to Lehman Brothers Holdings Inc. (LEH: 0.00 N/A) was very limited and that agency mREIT fundamentals should improve as Treasury bonds rally. Doug Kass at Seabreeze Partners agreed with George, citing the explicit government backing of Fannie and Freddie paper. The explicit backstop pushed swap rates down significantly, while the yield curve continued to steepen on the rally in short-term T-bills.

Kass said that he believes “Mortgage REITs are the prime beneficiary of the flight to safety in the financials sector,” and cited Hatteras as his favorite in the group.

Annaly Capital (NLY: 15.61 -8.18%) and American Capital Agency (AGNC: 18.68 +4.77%) were two others in the agency mREIT sector who were praised by Anton Schutz, the fund manager at Burnham Financial Industries, again for the steepened yield curve and removal of the GSE overhang. Annaly was upgraded from Neutral to Overweight by JP Morgan Chase & Co. (JPM: 47.05 +16.75%) analyst Andrew Wessel, who cited improved book value and a higher estimate for full-year earnings.

Impac In Trouble
Shares of Impac Mortgage Holdings (IMH: 0.40 +21.21%) took another nose dive after releasing first half 2008 results, posting successive quarterly losses on additional fair value writedowns. Impac is planning to ask shareholders to exchange its preferred shares for common stock to eliminate the associated dividend payouts and is also seeking to modify the interest rate on its outstanding trust preferred securities.

The company warned in its latest in 10-Q that if it is unable to accomplish these objectives, as well as reduce its operating expenses, “it may not be able to meet its contractual obligations for the next year.”

WASHINGTON – The American Bankers Association expressed deep concern that the Treasury's recently announced plan to guarantee money market mutual funds runs the risk of undermining the nation's banking system. 

In a letter to Treasury Secretary Henry Paulson and Federal Reserve Chairman Benjamin Bernanke, ABA President and CEO Edward L. Yingling warned that eight critical questions need to be answered before the program is finalized and any further long-term harm is done to the banking industry and the economy. 

"The debt instruments in a money market fund will pay a higher interest rate, and therefore, the fund will pay a higher interest rate than a bank deposit or short-term CD," said Yingling.  "It also appears that there will be no limit on how much an individual or institution can invest in these funds.  Therefore, they will be in a significantly superior market position to FDIC-insured bank deposits."

Yingling explains that a great majority of banks never made a subprime loan and have paid billions of dollars into the FDIC fund for the past 75 years.  And while the nation's financial system is under stress, 98 percent of banks are well-capitalized and reporting profits and continue to make loans in their local communities.

"Today's action will undermine the role of banks during this current crisis and has the potential to have an extremely negative impact in the future," he said.  "Simply put, the ability of bank to attract and keep deposits is being compromised in a profound fashion.  Our bankers are, understandably, very upset by the action."

Yingling asked Paulson and Bernanke to consider the following questions:

1. While the action is temporary, how will you address the perception by the market that money market mutual funds now have a permanent implicit government guaranty – much like Fannie Mae and Freddie Mac did?
   
   
2. Banks face a wide range of regulation and examination because of their FDIC insurance to ensure their safety and soundness.  What equivalent regulation and examination will be placed on guaranteed money market funds?  How will the government ensure the safety of its guaranty without equivalent regulation?
   
   
3. How will you keep corporations from taking unreasonable advantage of the lower cost of funding provided by the guaranty by moving more and more of their financing to commercial paper in these funds?
   
   
4. Will there be any limit on the amount an individual or institution can put in a guaranteed fund and still be covered by the guaranty, or will an individual or institution be able to have millions of dollars guaranteed by the government in a single fund?
   
   
5. The guaranteed funds will generally contain commercial paper of large, AAA-rated companies.  Those companies will now have a funding advantage because of the guaranty.  Funds will be moved from bank deposits to the guaranteed funds driving down interest rates large companies will need to pay.  Since banks are the traditional lenders to smaller businesses, less credit will be available for small businesses.  How will this impact on small business lending be addressed?
   
   
6. The FDIC fund consists of tens of billions of dollars paid by banks over the years, plus the interest the fund has earned.  While the announcement says that fees will be charged for the guaranty, those fees will not fund the guaranty program in any material way.  Unlike the FDIC fund, which is pre-funded by banks and then backed in the first instance by the almost $1.5 trillion in bank capital, this new guaranty program is in the first instance a direct tax-payer funded program.  How is that fair to the banking industry and what precedents are being set?
   
   
7. What is the exit strategy?  How do you remove the guaranty at the end of the temporary period without causing severe market disruptions?
   
   
8. Will the guaranteed funds have some type of obligation to serve their communities, equivalent to the Community Reinvestment Act, which applies to banks?