October 16, 2009

Happy Halloween!  Trick or Treat?

That's one way to look at the US economy during the third quarter where GDP growth beat most analysts expectations with a 3.5% annualized growth rate.  Was it a trick, or some kind of economic treat?  It sort of depends on how you look at it, but either way, we probably won't know for sure for another quarter or two.

You can already hear one side touting it as a huge treat.  The government stepped in when consumers and businesses were reeling most, and spurred some spending.  Those in the trick camp will tell you that we just got an injection of government steroids, and once those shots stop, so will the economic growth.

There's no doubt that the government stimulus drove the economic engine in the third quarter.  Of the $787 billion stimulus plan, about $207 billion has been spent (www.recovery.gov).   And, of the 3.5% GDP number for Q3, most of the boost came from housing (driven by the tax incentive) and autos (due to cash for clunkers).  Without that, it's very likely GDP would have been flat, or maybe even negative.

The question is, was it worth it?  I tend to think so.  Without the intervention, both economic momentum and psychology would have continued their downward trend, making recovery even harder.  

As we move into Q4, it'll be interesting to see if the increased consumption fueled by government stimulus can continue.  Personally, I'm skeptical, but at least the monetary and fiscal policies have put a floor under our economic slide.  But, with unemployment likely rising further, I don't see how we can expect a strong consumer to come back that soon.

That's partially why we saw the stock market give up all of Thursday's gains yesterday.  The hot GDP report got everyone fired up on Thursday, only to be dashed on Friday by the weak consumer spending number that posted a -.5%, dip, meeting analysts' expectations, but sliding back about 2% from the month prior's 1.4% mark, which was fueled by cash for clunkers and homebuyer tax credits.

This realization helped fuel a rally in bonds and mortgage backed securities, which is interesting because the waves of unprecedented supply continue to roll in.  Yet rates on mortgages and yields on treasuries remain very low because the appetite to soak them up seems to be strong.  Is money moving back into safety and income generation?  Is it a story of supply creating demand?  Or....are bonds, treasuries and mortgage backed securities over bought, meaning we could see a correction in the other direction in those markets?

As always, there are a lot more questions, than answers.

So, what will drive economic growth going forward?  I think we'll continue plodding along.  I don't put the recent GDP print as either a trick, nor a treat.  It was the result of the necessary evil of massive government intervention.

The real trick is going to come as we try to wean off this government crutch, live within our means, and increase revenue without imposing crushing tax increases on businesses and individuals that could risk pushing a fragile economy back into recession.

I'm glad I'm not faced with making those choices.  I'll just continue giving you my thoughts on how they may impact you and your finances.  As much pain and discomfort this economic cycle has created, there are valuable lessons to learn, and some terrific opportunities to sieze.

As always, if you, your family, or friends have any questions about financing residential or commercial real estate, please call or email me.  If you're in the market for a Jumbo ARM, the rates are screaming!!  Happy Halloween!  E 

Eric Grathwol

Loan Officer

Priority 1st Mortgage

3300 Douglas Blvd. Ste. 270

Roseville, CA 95661

direct: 916-223-4235

office: 866-771-9000

fax: 916-771-9099

www.priority1stmortgage.com

egrathwol@priority1stmortgage.com

October 16, 2009

Wow.  It's amazing what the expiration - or perceived expiration - of a government hand-out (errr...tax incentive) will do to boost sales. 

Cash For Clunkers created a spike in car sales in August - which promptly receded upon the program's expiration. 

I think the Homebuyer Tax Credits will do the same thing.  Looking at home sales for the four-county Sacramento Metro area, we've seen a huge spike in pending sales during September, in both month over month and year over year comparisons.  I imagine this trend will continue through October, since the program is currently set to expire for closings after November 30, 2009.

As I write this letter, pending sales and closed sales for October are only about 1/3 of September's levels, across the board, although we're half-way through the month.  But, that's not unusual, since most closings are scheduled for the last week of the month.  We'll see how it pans out.  I expect similar final #'s to September's.

In September, for pending sales in the price range of $150k-$200k we saw a 67% m/m spike and a 58% y/y increase.  In the $201k-$300k range pending sales rose 68% m/m and 48% y/y.  From $301k-$400k pending sales increased by 53% m/m and 38% y/y.  The $401k-$600k range saw increases of 63% m/m, but only 5% y/y.  And, even the higher end of $601k-$1mill saw pending sales - which to this point had been mostly down both m/m and y/y - increase by 115% m/m and 21% y/y.

That's pretty interesting to me, particularly since in most cases for our market, although we're seeing some month to month increases in sales, the year over year comparisons are basically flat, or down, across the board since the spring, when interest rates first hit their historic low of 4.625%.

And, ordinarily I'd expect that with low interest rates (a good 1% lower on average than 2008), lower home prices (down roughly 10% from 2008) AND the buyer tax incentives, sponsored by our tax dollars (well, really our borrowed tax dollars) that sales would be UP year over year from 2008.  But, that's not been the case.  It appears that it takes the expiration of a tax credit to move folks to buy homes.

So, that begs a few questions: 

• Why were people not buying homes in droves up to this point, given that rates are lower, prices are lower, and Uncle Sam was doling out cash? 
• Is this spike in sales simply pulling sales forward w/ folks looking to capitalize on the tax credit, who would have bought a home anyway? 
• Is this tax incentive creating any new demand from home buyers who would otherwise not be buying? 
• Will the home buyer tax incentive actually expire or will it be extended? 
• And, what will happen to home sales when that tax credit is finally closed, whether Nov. 30th of 2009, or some future date?

If you listened to the main stream media, you might think that the reason people aren't buying is because guidelines are too strict, and it's hard to get financing. 

Although guidelines are definitely tighter, they're basically back to where they were 10 years ago.  You have to have a job, be able to verify your income, have some savings and have decent credit to get a loan.  But, if those things all line up, financing has never been cheaper.

Rather, I think that in California, and most of the country, people aren't buying in droves because... they're not working too much.  In California, unemployment is in the 12% range.  If we look at the under-employed, and those who've quit looking for work (which is around 16% on the national level) I'd think we'd see true unemployment pushing 20% here in California.  And, the Sacramento area is particularly loaded with government employees, many of whom are furloughed.  It's tough to go buy stuff, particularly a home, when you're not working or making less than you're used to making.

As for the impact of the tax incentive, I see that as icing on the cake for buyers.  I don't believe it drove a significant amount of fresh demand from buyers who would otherwise not have bought.  I think many of them have been diligently shopping for homes, hoping to find one that fits their needs so they can use the tax incentive.  I wonder how many of them compromised on the home they wanted, just to get in contract and close within the current deadline?  To me, a few grand is nothing, compared to being happy in your home for 10+ years.  But, maybe some don't see it that way.

I expect home sales, for the most part, are being pulled forward, that would have occurred anyway.   I have no way of knowing hard data on buyer's intent and timing, but I don't think the incentive pushed people who were otherwise planning to keep renting to go buy a home.

I do think the tax credit will be extended, and possibly even expanded.  It's not in the news much, but there is a bill currently moving through Congress with growing support that will extend, and possibly expand, the homebuyer tax credit.  There's certainly a lot of lobbying force pushing Congress down that path.

So, what will happen when the free money is cut off?  Will we see a similar decline in home sales that we saw in car sales upon the expiration of the Cash For Clunkers program?  I think it's likely that the pattern will repeat.  What will the talking heads say to that, as they point to the recent sales spike as further evidence of a turnaround in real estate?

There are just so many homes (like three million) that still need to move through the system that I don't see a clear, sustainable upswing in sales just yet.  You can't make people buy things they can't afford.  If I recall, that's part of how we got here in the first place. 

But, in the same breath, I do think we're finding a bottom to the home pricing correction.  Data points to slight month over month price increases - whether those are sustainable or not, or driven by the spike in sales, is another question.  But, things do appear to be firming, however slowly.

Meanwhile, we're seeing pretty much every other asset class rising, too.  The Dow Jones Industrial Average just closed above 10,000 the other day for the first time in a year (and the 26th time in history) and the media is celebrating, despite the fact that it first did so 10 years ago.  Bonds and Mortgage Backed Securities have also been rallying, pushing down yields and rates.  Commodities continue to advance.  And, that brings me to another question:  When in history do we see all these things moving higher at the same time?  Not too often, and typically, Mr. Bond Market tends to be making the correct call vs. Mr. Stock Market about the overall direction of our economy.  Whether it is this time, or if we are entering some new paradigm where jobs are lost, people spend less, but corporate profits rise, our economy still grows, and inflation picks up, only time will tell.  I'm certainly not betting on that new paradigm coming to pass.

Although I think the worst shocks are behind us - we still have a lot of debt out there to either pay down, or....just write off.  That won't be a pretty process, and it will take years, not months.  The commercial losses are just now really hitting the fan in full force.  Those will dwarf the residential loan losses.  It's going to be interesting to watch it all unfold.  Retailers have closed 8300+ stores so far in 2009, two thousand more than closed during all of 2008.  I could go on.  The era of excess is unwinding in the US, as it should.  Then, we have to rein in our government spending.  As you may have seen, the projected deficits continue to increase from already staggering amounts.

We will return to growth.  We will return to full employment (roughly 5% unemployment rate) and, home prices will rise over time, but...again, that will all take years, not months to turn the corner.

In the mean time, we know that home prices are back to where they were in about 2002-2003.  Interest rates are at historic lows and...it's a great time to buy, for those who are well positioned to do so.  And, there are some very viable ideas out there that are free to us taxpayers that could do a lot to firm up our housing market.  Hopefully, they will gain traction in Congress.  More on those ideas in another letter.

As always, if you, your family, or friends have any questions about financing residential or commercial real estate, please call or email me.  Here are today's rates.  If you're in the market for a Jumbo ARM, the rates are screaming!!  Cheers!  E 

Eric Grathwol

Loan Officer

Priority 1st Mortgage

3300 Douglas Blvd. Ste. 270

Roseville, CA 95661

direct: 916-223-4235

office: 866-771-9000

fax: 916-771-9099

www.priority1stmortgage.com

egrathwol@priority1stmortgage.com

August 25, 2009

What will happen to fixed mortgage rates when the Federal Reserve stops buying Mortgage Backed Securities later this year?

Here's my prediction: Not a lot. 

Some people fear fixed mortgage rates will skyrocket.  I'm not one of them.  Worst-case, I think we return to the 6% range, where we were before the Fed's intervention a year ago. But, I actually think they'll hover in the current trading range around 5% to 5.5% for some time.

The Fed definitely stepped in and created a market when it was dying on the vine in the Fall of 2008.  Last year, prior to the Fed's November 25th announcement that they'd buy up to $500 Billion of Fannie Mae and Freddie Mac's mortgage backed securities (subsequently expanded to $1.25 Trillion in the Spring of '09) 30 year fixed interest rates were hovering around 6%-6.5%. 

We'd seen two or three windows of opportunity in 2008 where rates hit 5.5%, but it wasn't until the Fed's November announcement that rates dipped below that mark, and hit as low as 4.5%-4.625% for a short time.

The Fed's expansion of that program in the Spring of 2009 helped mortgage rates dip again, and hover between 4.625% and 5% until May, even as the stock market was rallying off the March lows.  That's important, because usually when stocks advance, that's shifting the supply/demand equation, pulling money out of the relative safety of bonds and mortgage backed securities, moving it into higher risk/reward equities.  But the Fed's purchase program undoubtedly picked up much of that slack.

Additionally, the stock market rally was (and still is) fairly low volume, which could mean that a lot of money still needs to be placed where it's relatively safe, but earning more than zero.  On that note, 3-month Treasuries are paying just 13 basis points above zero (a basis point is 1/100th of 1%, and as the stock rally continues to have legs, the yield on the 10-yr Treasury is coming down, very close to breaking below a key level of 3.4%.  Under "normal" circumstances, we'd expect the yield on Treasuries to rise, when the stock market rallies.  (As an aside, the 10yr Treasury yield actually closed at 3.398% today).

From May into August, mortgage rates came off their floor and were hovering in the 5% to 5.5% range again.  Still terrific fixed interest rates, but...we get spoiled easily, don't we? 

Then, as the second quarter came to a close, and economic "green shoots" began turning brown, money found its way back into the MBS market, bringing 30-yr fixed rates back below 5% to 4.875%, just .25% above their historic floor.

Enter 3rd Quarter.  We had "cash for clunkers," ongoing incentives for first-time homebuyers, and consumers benefited from a slight tax reprieve via the economic stimulus plan enacted after Obama took office.  As a result, Q3 GDP is expected to show about a 3.5% growth rate.  Meanwhile Q2 GDP was revised to a better than expected -1%.  But, how much of that was due to government intervention, rather than organic growth?  Quite a lot.  Moreover, will this improvement continue into, and through Q4?  We'll see.

I do believe the worst is behind us, economically.  But, we're just now beginning to see the first wave of commercial defaults start to rise.  That poses significant risks for our banking/financial sector.  Unemployment is pegged to rise through much of next year.  And companies, for the most part, are still seeing their top line sales decline. 

The government stimulus should continue to keep the wheels on the car, for now, but in this tough environment, I think it's likely that the stock market will start to retrace some of its recent gains - as it becomes clear that the recent growth is not fundamentally sustainable without continued government intervention, which of course breeds another set of challenges.  The timing of this realization is likely to occur around the tail end of Q4 2009 or Q1 2010, basically coinciding with the Fed's unwinding their MBS purchase program.

And, since many investors have ridden this stock market wave, posting significant gains, it may be time for some profit taking, where they'll cash out and park funds in less risky, yet still substantial returns of MBS, treasuries and corporate bonds.

They can choose US Treasuries - little return, and virtually no risk.  Or, they can assume slightly higher risk, and buy up Mortgage Backed Securities, municipal bonds (there was a recent spike in that market, too) corporate bonds, etc. 

If you're buying recent vintage MBS, from 2008 and 2009, unless the seller is stuffing their bundle with older vintage loans, you're getting mortgages with at least 20% equity cushions (and much more in many cases) backed by borrowers with stable and verifiable income, assets, and solid credit histories.  Even accounting for some incremental job losses, and another down leg in home values, "most" of those newly minted loans should perform within historic ranges, with defaults in the 1% range.

And, if I can get a return of 5.5% on my money - in what I would term a pretty safe environment - that's not a bad deal.  Particularly if we do find ourselves in a deflationary environment.  Then, my actual returns could be 6.5% to 7.5%.  Not bad!  8% annualized returns are what the Stock Market Gurus sold us as standard for years - despite the fact that the major indices (Dow, S&P and NASDAQ) are basically in the same place now, as they were 10 years ago.

On top of those factors, since the Baby Boomers have seen their net worth plummet through declines in asset values (both in stocks and real estate) they may shift much of their portfolios to income generation, rather than equity appreciation.  This could further fuel demand for MBS and other income driving investments.

Sure, there were and continue to be some great runs and huge opportunities to make money in stocks - as long as you or your financial planner/broker buy the right stocks and move in and out of the market at the right times, but...as we know, that's easier said than done.

Investors may decide that's not worth the risk - in the near term - when they can park their funds in safer investment vehicles, and still net some handsome returns.

That's why I think mortgage rates will not see much of a jump - if any - as the Fed winds down their purchase program.  And, if The Fed believes otherwise, I'm fairly confident they'll extend the program accordingly.  They're going to do everything they can to reflate our economy.  And higher borrowing costs for consumers would add pressure to what may already be a pretty weak and tenuous recovery.

But, as always, time will tell.  Maybe we will indeed see a V-shaped economic recovery.  That's certainly what the stock market is anticipating.  Just because I don't see it playing out that way doesn't mean it won't happen.  We'll see as we continue moving through this cycle, and I'll do my best to keep you posted.

In the mean time, if you, your family, or friends have any questions about financing residential or commercial real estate, please call or email me.  Here are today's rates.  If you're in the market for a Jumbo ARM, the rates are screaming!!  Cheers!  E 

Eric Grathwol

Loan Officer

Priority 1st Mortgage

3300 Douglas Blvd. Ste. 270

Roseville, CA 95661

direct: 916-223-4235

office: 866-771-9000

fax: 916-771-9099

www.priority1stmortgage.com

egrathwol@priority1stmortgage.com

August 25, 2009

What does our economic recovery mean for interest rates?

I wish I knew, exactly.  But, all I can really do is make an educated guess.  As you can imagine, it's very dependent on what type of recovery we see.

You're probably hearing the same alphabet soup of recovery letters I am - will it be a V shaped recovery, which is how most recoveries over the last 80 years have been?  Maybe it'll be a slower slog, shaped like a U (or even a bathtub, with an elongated trough, before slowly curling into the upside of the U)?  Could we see a W?  That's basically two back to back Vs.  What impact would that have on interest rates?  And then there's the L - like Japan's "lost decade."  How would that play out for our borrowing costs?

As you know, there are two basic factors that drive mortgage rates.  First is supply and demand, and second is inflation, or fears of it. 

Despite what we hear in the main stream media, mortgage rates are not based on the 10-year Treasury yield.  Investors doling out the money to borrowers set mortgage rates they demand for their return on investment.  They adjust for the risk/reward they're taking and the opportunity cost of not placing that money elsewhere.  There is no direct linkage to Treasury yields.  There's a small correlation between the yield on the 10-year Treasury yield and mortgage rates, because both offer similar "safe" long-term investments, with similar rates of return, but it's not a direct link.

For example, right now the 10-yr Treasury yield is around 3.45%, and 30yr fixed mortgages are at 4.875%.  Treasuries have very little risk of default, because they're backed by the full faith and credit of the United States, but... investors may choose to accept a little more risk - since guidelines are not so loose anymore - and park their funds in Mortgage Backed Securities, returning about 1.5% more than Treasuries.  Or, they can bet on corporate profits driving up share prices and yielding greater returns from the equity markets.  Or, there are other bonds, real estate, and a myriad other investment vehicles.  Lots of places to make money, and mortgage backed securities are their own animal, priced based on supply/demand, and... Inflationary pressures - or lack thereof.

So, a V-shaped recovery - which I think is the least likely scenario for our recovery - would tend to bring about rising interest rates faster than any of the other possible outcomes. 

If we see a V-shaped recovery it would mean that corporations' top and bottom lines are growing, fueling economic growth where personal consumption has lagged.  They're selling more stuff, charging more for it, and boosting profit margins.  In such an environment, stock market returns would likely be strong relative to the perceived risk.  So, investors would pull money out of savings, and safer investment vehicles (bonds, mortgage backed securities, etc.) to deploy that money in stocks for greater returns.  This would decrease demand for those bonds and MBS, at the same time that the supply of Treasuries is burgeoning - to finance our increasing deficits.  With supply up, and demand down, rates would rise to entice investors to keep money in bonds/treasuries/mortgage backed securities rather than deploying it elsewhere.  However, as I've said before, I think the excess capacity in our economic engine, combined with rising unemployment, increased savings, and decreased consumption will likely prevent us from seeing too much of a V shaped recovery, despite the stock market's current rally.

A U shaped recovery would have our economy lazily kicking around the lower end of the recovery spectrum for a period of time - possibly an extended period - if our recovery ends up more like a bathtub, than a U. 

In this environment, corporate earnings would likely languish for some time.  They've done an amazing job of cutting costs, increasing productivity and protecting margins so far, despite significant drops in sales across most industries.  But, cost-cutting can only go so deep.  We may be close to that point.  Once you've cut to the bone, you have to start healing the flesh to grow again.  Where will that growth stem from?

In this U shaped environment, corporate earnings may languish across most industries for a while.  There will certainly be winners and losers, and occasional rallies, as well as niches where pricing power remains in tact, or new growth is solid, but for the broader economy, this could be a tough environment. 

We may find that the recession ends, but...it won't feel like it to the 1 in 10 people who don't have a job, and another 1 in 10 who are working less than they want/need.  In this environment, investors may welcome a steady, relatively safe return for their savings, driving demand for bonds, treasuries and mortgage backed securities, thus keeping rates relatively low.

A W shaped recovery would probably be pretty volatile with wide swings in all markets across asset classes.  We're sort of seeing the stock market on this trajectory now, without any real turnaround in the underlying economic fundamentals - at least not yet.  This would be an environment where keeping your eyes on the road would be critical.  Having a sense of the underlying trends in equities and fixed investment vehicles would be invaluable to making the right decisions about how and when to deploy your money.

Lastly, there's the L-shaped recovery.  It's really not a recovery at all.  It could be akin to Japan's "lost decade" where, according to The Guardian "From its 1989 peak of 38,916, the Nikkei stock average fell 63% during the 1990s; land prices slumped - a far cry from the days when the grounds of the imperial palace in Tokyo were rumoured to be worth more than all the real estate in California."  But, I don't think this scenario is very likely to unfold for the US. 

The Bank of Japan was slow to react to their crisis.  They waited 17 months to cut their overnight lending rate, and only in the mid-90's, five to six years after their asset bubble burst, did they get down to .5%.  Our Fed, on the other hand, went from 5.25% to .25% in about 18 months, from the mid-2006 to their December 2008 meeting, when they hit the range of 0%-.25%, where we still sit today.

Additionally, Bernanke and company pulled out all the economic tools and levers.  They pumped massive amounts of liquidity back into our system.  Yes, their balance sheet exploded, but it definitely helped a really bad economic event from turning into an economic disaster.  More importantly, to very little fanfare, the Fed's balance sheet has actually shrunk this year, and is no larger now than it was just after the Lehman Brothers collapse.

And, just today, for this Bernanke has been rewarded - as I think he should be.  I'm sure he'll face some heat as he is questioned by Congress to confirm his reappointment, but... Uncle Ben is the man.

And, it will be interesting to see exactly how Bernanke guides us through this cycle.   He'll also have two new Board members, since Obama will likely make appointments for seats that have been vacant since 2006.

Hopefully, they'll be able to engineer us back to a solid foundation for economic growth.  I'm confident they will.  And I'm sure it'll prove interesting, too since they're walking a tight rope of inflation and deflation as they cross over to renewed economic growth.

Once there, they'll have to impress upon our administration and Congress that as we return to stable economic growth, it must become a priority to reduce our budget deficit.  You can already hear this in Bernanke's talking points.  The trajectory we're on now with our federal spending is unsustainable over the long haul. 

Clearly, as Japan has evidenced, our debt to GDP ratio can climb significantly for an extended period, without driving inflation, but...at some point they - and we if we follow their path - will have to pay the piper.  So far, our piper - China and our other creditors - are playing a nice tune.  But, at some point, they may start to worry if we don't clearly voice our plan to repay them.

As always, I don't know how this will all play out, but I'll do my best to keep you posted, so you can make the most of your opportunities.

In the mean time, if you, your family, or friends have any questions about financing residential or commercial real estate, please call or email me.  Here are today's rates.  Cheers!  E

Eric Grathwol

Loan Officer

Priority 1st Mortgage

3300 Douglas Blvd. Ste. 270

Roseville, CA 95661

direct: 916-223-4235

office: 866-771-9000

fax: 916-771-9099

www.priority1stmortgage.com

egrathwol@priority1stmortgage.com

August 3, 2009

Have you ever taken a road trip, knowing your destination, but not knowing exactly how to get there?

I've used that analogy before.  It's very fitting for what Fed Chairman Ben Bernanke and his car-load of Federal Reserve Board members are doing as they guide our economy back through recovery to stability. 

With a broad brush, there are two major economic debates right now.  They are whether we're facing an inflationary mountain, or a deflationary quagmire.  And, the road we forge back to economic stability will play a huge role in your financial future.  It will dictate the interest rates you pay, and the return on capital you get.  It will shape the types of opportunities you can seize and drive the challenges you will face.

The Federal Reserve's job is to navigate their way forward, fulfilling two basic mandates: to maintain price stability, and full employment.  That's the destination.  How they get there, particularly in times of economic crises, can be the uncharted road trip. 

Imagine Bernanke et al in the Federal Reserve System driving our "economic mini-van" with the US Family aboard.  The "kids" in the back seat (we consumers, business owners, the politicians in Congress, etc.) keep wondering "are we there yet?"  Meanwhile, the back-seat drivers (other economists, primarily, but some Congress members too) alternately scream "we're doomed, we'll never make it" and "wait, hit the brakes, we're there!" 

Some recent sign posts we've all seen include:

• The S&P 500 index closing above 1000 today, for the first time since November of 2008, when the wheels appeared to be coming off our economy.
• Steady declines in the numbers of layed off workers since job losses seem to have peaked around January 2009
• Increasing unemployment - now upwards of 9.5% nationally.  And, if you count the "underemployed" those working part time who'd prefer full time work, that's more like 16%+.  Both are projected to go higher, too.
• Sliding consumer sentiment and spending, which peaked at driving 70% of our Gross Domestic Product
• The highest personal savings rate we've seen in about 20 years
• Q2 corporate earnings reports predominantly beating expectations
• Skyrocketing national debt

But, each sign post has a different meaning, depending on the eye of the beholder.

Deflationists worry our economy may languish in an environment of falling prices for years, possibly decades, much like Japan has done since the bursting of their credit and asset bubbles in the 1990's.  Japan's overnight lending rate - comparable to our Federal Funds Rate - has hovered around 0.5% for the better part of a decade.  Their Nikkei Index - similar to our Dow or S&P indices - has declined from the 16,000 range in the summer of 1999 to just over 10,000 today.  You'd find a similar deflationary story looking at Japan's real estate, and most other Japanese asset classes over the same time frame.  All that despite loose monetary policy.

Inflationists fear hyper inflation, of the type that grips Zimbabwe today, rendering their currency less valuable than the paper on which it's printed.  Or like the inflation that helped bring down Germany's Weimar Republic in the early part of last century, when people were carting wheelbarrows of cash to buy a loaf of bread.  The inflationists point to the massive infusion of cash the Fed has pumped into our system.  They point to the ongoing government stimulus packages - we've already had two, and a third is being discussed - that continue driving our nation further into debt.  And, they claim, that at some point our debt will be unbearable, and that China - who currently gives us our allowance - may change the terms under which they want to be repaid.  Lastly, these folks worry, that the only way to climb out of the mountain of debt we've built for ourselves would be to devalue the dollar, forcing inflation to effectively reduce our financed deficits.

My take?  I don't see either catastrophic inflation, or a prolonged deflationary morass gripping our economy.  In Uncle Ben I trust.  And no, I don't think he's our crazy Uncle...

But, I do wonder where our economic growth will spring from, and how on earth - just 4 months after our stock market was pricing in Armageddon - it's pushing itself further and further off those lows - when really, we haven't seen any positive economic sign posts of the usual sort, but rather just "less bad" news.

I peg the recent run-up in stocks as a bear market rally - driven by corporate cost-cutting (propping up earnings) psychology/optimism and group think, more than anything.  It reminds me of the rebound we saw in stocks after the 2001 tech bubble burst.  By 2002 I thought the stock market losses had largely been realized.  I invested a bunch of money.  Shortly thereafter, the market dumped again to the 2003 lows.  I lost.  And, the economy as a whole was MUCH stronger then, than we are now, when you compare employment/unemployment, production, average earnings, etc.  The tech bubble bursting was "relatively" contained.  The credit, housing and asset bubbles were much more pervasive and far reaching.  Their bursting has touched every sector of our economy (and the world's) as everyone - but our government - is deleveraging.  It seems that as this year continues, we may see another pull back in stocks as revenues continue to languish, and they can no longer cut costs to protect their margins.

As for the lost decade the deflationists fear?  Our Fed was much more creative, speedy, and forceful than the Bank of Japan was during the bursting of their asset bubble.  Bernanke and Co. aggressively cut the overnight Federal Funds rate.  They created an alphabet soup of programs to pump liquidity (credit and cash) back into our economy.  They implemented an extensive asset purchase program, buying both US Treasuries and Asset Backed Securities.  And, from a fiscal standpoint, both this year and last Congress approved temporary tax cuts which put a little extra money in people's pockets.  From my perspective, although economic sign posts aren't yet getting better, just less bad, they are no longer showing shorter milestones to Armageddon.  I think the worst is most likely behind us.

Inflation, on the other hand, should be manageable because most of the Fed's programs expire as their demand wanes.  In fact, their balance sheet is shrinking even now.  Some of the programs are also generating decent returns, which can be used to pay down our debt.  In terms of the increased cash supply, which right now is basically sitting in reserve and not being deployed in the economy, the Fed can increase the interest paid on those reserves.  According to Janet Yellen, San Francisco Federal Reserve Bank President, "An increase in the interest rate on reserves will induce banks to lend money to us rather than to other banks, thereby pushing up rates in the interbank market and, by extension, other interest rates throughout the economy. This is an important tool because, even if the economy rebounds nicely, the credit crunch might not be fully behind us and some financial markets might still need Fed support. This tool will enable us to tighten credit conditions even if we maintain a large balance sheet for a time." 

Additionally, how can we have inflation when the labor force is contracting, hourly earnings are declining, and nobody - well, all but a select few - have any pricing power to raise prices on either the wholesale or retail level?  Yes, if China's middle class burgeoned overnight (consumer spending only drives about 40% of their Gross Domestic Product) and began an era of consumption like we just went through, that could drive inflation.  But, we're probably a decade or two away from that happening.  Their culture is still vastly driven by frugality, rather than consumption.  So, I don't see an epic bout of inflation, either.

But, there is at least one other concern on our horizon.  It's trumped right now by the immediate challenge of repairing our "economic mini-van" but.... Our national deficit is a looming problem.  The interest expense of financing our deficit could become crushing if we don't curb it.  Add to that, the bloated entitlement programs we've promised (social security, medicare, etc.), not to mention new programs on the table, and.... some economists project that our tax revenues would need to climb to 68% of earnings (and if tax revenues are 68%, then tax rates would have to be even higher) to cover our debt service and entitlement programs.  THAT's scary.

Fortunately, we can kick that can down the road.  At least until we're certain that our "economic mini-van" is cruising ahead, back on its road trip, avoiding speed bumps and pot holes, along the way.

I'm counting on American creativity, ingenuity and resilience to pull us through this cycle and on to the next one.  We do have a bitchin' set of tools...In our nation's history we've overcome challenges time and again. 

In terms of impact on near-term mortgage rates, I think we'll continue on our slow trend up for 30yr fixed mortgages.  If we see a significant economic relapse, look for those rates to dip again, as money makes it's "flight to safety."  But, on the other hand, I won't be surprised to see rates touch 6% in the next 12 months or so, either.  Meanwhile short and mid-term ARMs are likely to stay low, in the 4.5% range - steepening the yield curve, but not to excessive levels.  We're close to the 1.5% or so spread between short-term and long-term mortgage rates now.  And, I don't see those rates going too far below 4%, their recent floor, either.  But, as always, time will tell.

In the mean time, if you, your family, or friends have any questions about financing residential or commercial real estate, please call or email me.  Here are today's rates.  Cheers!  E

Eric Grathwol

Loan Officer

Priority 1st Mortgage

3300 Douglas Blvd. Ste. 270

Roseville, CA 95661

direct: 916-223-4235

office: 866-771-9000

fax: 916-771-9099

www.priority1stmortgage.com

egrathwol@priority1stmortgage.com

July 7, 2009

Since we've put the first half of 2009 behind us, it's time to review the predictions/educated guesses I made for this year, and see how on - or off - the mark I was.

1) Mortgage Interest Rates:  I did well on this one.  I thought mortgage rates would hover around the 5% range for 30yr fixed conforming loans (those under $417,000) for most of the year because of the Fed's tactic of buying Mortgage Backed Securities and Treasuries.  I've been right, so far, even though they held well below 5% for a good while longer than I'd anticipated.  At the mid-point of the year, the Fed is about half way through with purchasing their initial allocation.  I think their continued purchases, and the languishing stock market might lead to money shifting, back into bonds and Mortgage Backed Securities and open another window of sub 5% rates.  In fact, with earnings season about to begin for Q2, I'm looking for that window to open any day.  Jumbo rates (true Jumbo, those over $625k) have indeed moderated, as I'd predicted.  In January, they were upwards of 8% for 30yr fixed.  They're now down below 7% again.  I don't see them drifting too much lower for some time, still.  But, 6.5% or 6.75% isn't bad!  And, Jumbo ARMs are in the mid-4%s to mid-5%s.

2) The Housing Market:  Jury's still out on this call.  I said we'd bottom in 2009.  I believe we'll bottom in California later this year, maybe early next - nice broad window for me to hit...  But, if we consider that real estate appreciation could be a mean-reverting trend, we could overshoot the correction to the downside, before reverting to the historic average.  Here in the Sacramento area it looks like new listings are down in most price ranges, pending sales are up, and actual closings are down.  All of that could illustrate that we're working our way through the excess inventory, and returning to a more normal market.  If you're interested, I can email you the stats for the four county Metro Area I've been tracking.  Let me know.  Of course, there's still a lot of inventory that's already bank owned, but not yet on the open market.  Not to mention the folks already in foreclosure, and those who are behind on their mortgages, who may fall into foreclosure.  So, this could merely be a plateau before another little dip down, instead of a true bottom.  Time will tell.

3) Word of the Year: I had two.  Stagdeflation and Quantitative Easing - Well, I was a little off on this one.  These terms haven't found their way into the mainstream media yet, and you probably haven't heard them, unless you're a finance and economics dork, like I am.

4) I thought our economic stimulus would be a pork barrel magnet.  We'll see.  It's too early to tell, since the dollars are barely hitting the street now (unless you're on Wall Street).  But, I did hear a report that Barney Frank - after leading the charge to have GM move through bankruptcy (not that that was a bad idea, but...c'mon Barney) to become leaner and meaner - convinced the newly appointed CEO to delay closing of a plant that operated in his district - to save jobs.  Never mind that it may not have been an efficient use of their resources.  That's likely just the beginning of those shenanigans.

5) Debt forgiveness:  Yes, mortgage debt forgiveness.  It's happening, but not that widely yet, so I'll give myself half a point.  Ocwen has cut principal balances on about 20% of the loans they modify.  I'm sure other investors and servicing companies are too.  We might start hearing more about it as we move through this cycle.  But, as you can imagine, lenders/investors probably want to keep that on the down low.

6) My freebie: Commercial Real Estate collapse.  This is taking a little longer to fully materialize than I'd expected, probably partially due to changes in the "mark to market" accounting rules, and all the money banks have been plowing into their balance sheets, so they're delaying the inevitable.  But, we continue to hear about more and more commercial property bankruptcies, foreclosures and delinquencies.  Names like General Growth (the largest mall owner) and Red Roof Inn are a couple recent casualties.  I think we're just at the tip of that iceberg

So, that's 3.5 out of six.  Not bad, for educated guesses, I guess...

In my next update, I'll try to address the heavyweight fight between inflationists and deflationists and what it means to you.

In the mean time, if you, your family, or friends have any questions about financing residential or commercial real estate, please call or email me.  Here are today's rates.  Cheers!  E

Eric Grathwol

Loan Officer

Priority 1st Mortgage

3300 Douglas Blvd. Ste. 270

Roseville, CA 95661

direct: 916-223-4235

office: 866-771-9000

fax: 916-771-9099

www.priority1stmortgage.com

egrathwol@priority1stmortgage.com

June 12, 2009

Who's afraid of a little inflation?

Granted, if you missed the latest window of opportunity with super-low interest rates, where they ranged between 4.625% and 5% for about 6 months - you might be a little bummed about the market's fears, and the recent rate hikes they've spurred.

But, from a home buyer's perspective, I always think it's best to find the home that meets your needs and goals, whether as a primary residence or investment property, rather than trying to time anything.  Rushing to buy - simply because rates are low - is a little like buying that suit you don't really need - just because it's on sale.  Sure, you saved a few bucks, but...you may have spent money, or bought a suit, you otherwise wouldn't have.  And, to keep things in perspective, even if rates head back to the 6%s - and they will at some point - those are still great!

From the refinancing standpoint - absolutely, the last six months represented an unprecedented window of opportunity to lower your interest rate and net some real savings.  A lot of people flew right through that window, saving them some real money.  Others wanted to wait.  Some were hoping for even lower rates.  Others were riding the low points of their adjustable rate mortgages.  And others may have just figured the savings they'd net weren't that important.

Either way, I do think there's a better than even chance we'll see 30 year fixed mortgage rates dip back down below 5% again.  So, if you're at all bummed you missed the last window of opportunity, line up your ducks and be ready to move as soon as the next one opens.  If it does, I don't think it'll be as long lived as this round.  But, the recent run higher is a little out of place, too.

What's driven mortgage rates and Treasury yields up recently, are fears of inflation stemming from all the stimulus/recovery/bailout efforts, the burgeoning supply of Treasuries issued to fund those efforts, and hopes that those efforts are returning our economy to growth - so money is flowing out of "safe haven" investments back into riskier equity markets, that "could" yield greater returns.

However, here's why I think inflation will likely be kept at bay.  Why the supply of Treasury issuance and Federal Reserve's balance sheet growth is manageable (at least in the short and medium term).  And why our economy will not return to trend growth (3%+ GDP growth) for some time, which will likely subdue corporate and equity returns, allowing investors to keep money in Treasuries and bonds, without suffering significant lost opportunity costs.

I believe inflation will remain in check because of the massively deflationary impact of the housing and credit bubbles bursting.  Our economy, more than two thirds of which is driven by consumer spending, is healing and will heal.  However, the base line is likely to be somewhat lower than what we've seen over the last 20+ years.

In order for inflation to really take hold, we need to see upward wage pressures, in addition to an increase in the cost of goods.  Currently, both of those metrics are heading backwards.  Yes, we're seeing a slow-down of job losses.  That's a good thing.  But, by looking deeper, we see that average wages, and hours worked are being cut.  The average work-week dropped to 33.1 hours for May, and average weekly earnings have dipped by .7%, on an annualized basis, over the last three months.  That means that companies are saving money on labor, without hacking quite as many jobs. 

So, what happens if you're working fewer hours, and making less per hour?  You might stop spending as much.  And, since you don't have the ol' housing ATM, and your 401k/retirement account value has probably been hacked, you might be trying to SAVE money, while also spending less.

It follows from there, that if income and hours worked are down, spending is down, and savings are up, companies vying for your business - and believe me, they're vying - "might" lower prices to entice you to buy.  Basically, businesses have absolutely no pricing power right now.  Anyone shopped for a car lately?  There are some amazing deals.  But, car sales are still in the tank.  So, looking solely at a decrease in headline job losses can be misleading.

Beyond that, during the Consumption Era that peaked in the early 2000s, way too many malls, office buildings and homes were built.  Companies ramped up their capacity to feed what they didn't realize could be short-term demand.  How often do you ask yourself "Geez, there's a Starbucks (or name your chain store) here?  Didn't I just pass one down the street?"  In Sacramento, I do it all the time - or used to.  There is a pretty large oversupply and overcapacity for almost everything, it seems.  As a business, that's now a cost-center, not a profit center.  So, they'll continue cutting that overhead, one way or another.

To whom will companies sell their wares to make profits?  Without a return to strong consumer demand - and spending driven growth - where will inflationary pressures stem from? 

Some say they'll stem from all the new money rolling around that the Fed is flushing into the system, and that because we're financing that influx through debt, our debt servicing costs will rise, driving inflation from that side too.  I'm not convinced that will necessarily lead to uncomfortably high inflation, either. 

So far, despite unprecedented Treasury issuance and a few scathing remarks from China's Ministers, foreign demand for our Treasuries has actually grown, with foreign participation at yesterday's bond auction coming in at 49%. 

Additionally, Japan's Finance Minister, made a strong statement affirming his comfort with US Treasuries, and his belief that current yields are "attractive."  Since Japan owns nearly as much of our debt as China, within a 100 billion or so at $687 billion, those words carry some weight.  Granted, some of that may be reciprocal stroking, but... it still bears consideration.

The growth of the money supply and the Fed's balance sheet can also be unwound relatively quickly, as most of it was short-term in nature.  And, so far, much of that extra money is still sitting on the sidelines in case they need to cover future losses.  Moreover, according to the Fed, that money can "simply be allowed to run off as the programs and facilities are scaled back, or shut down" which will soak up much of the liquidity they've injected into the system.

And lastly, I believe - although I might be wrong and maybe missed a golden buying opportunity at March 2009's stock market low's - that the "green shoots" people are seeing are merely fuzz that will be mowed once or twice before our economy really heads back towards trend growth.  A review of the Fed's latest Beige Book economic summary highlights:  "Reports from the Federal Reserve Banks indicate that overall economic activity contracted further or remained weak. However, five of the twelve Districts noted a moderation in the pace of decline, and several saw signs that activity in some sectors was stabilizing at a low level."  So, in less than half of their reporting districts, things were "less bad." 

Additionally: "Manufacturing activity weakened across a broad range of industries in most Districts, with only a few exceptions."  And: "Downward pressure on prices was reported across Districts."  Then: "Districts that report on nonfinancial business services said demand continued to fall across most industries."

Plus: "Consumer spending remained generally weak." And: "Housing markets remained depressed overall, but there were some signs that conditions may be stabilizing. New home construction activity fell further, however, as inventories remained elevated.  Home prices continued to decline in most Districts, although a few reports noted that prices were unchanged or that the pace of decline had eased."  And on the commercial property front: "Nonresidential real estate conditions continued to deteriorate over the past six weeks. Demand for office, industrial and retail space continued to fall, and there were reports of increases in sublease space."

If I'm correct, then we're looking at a period of slowly slogging along a lower plateau of economic performance.  In that environment, I think it's likely equities will slide again as the reality sets in that we're going to get a period of "less bad" but not "good" news on corporate earnings, layoffs, and our long climb out of our Consumption Era, as we work to find a new "normal" foundation to foster economic growth.

For all those reasons, plus the fact that the Fed is still buying Mortgage Backed Securities and Treasuries - they're about half-way through what they said they'd buy, which can be extended if needed - I think we could see another dip in mortgage rates.  If it's important to you, be ready. 

If there's one thing that's certain, these low rates cannot and will not last forever.  In fact, the Fed Futures market is betting a 58% chance of a Fed rate hike by November.  I think that's ludicrous, based on the economic backdrop, but.... that's just my opinion.  I could be wrong.  It has happened before...

And, keep in mind - this is a short-to-medium term forecast (or educated guess, really).  Our deficits and entitlement programs will need to be dealt with, in the medium-to-long term, which adds another layer of complexity to managing steady economic growth, interest rates, and inflation.  Fortunately, I don't have to navigate those decisions.  I'll just report my thoughts.

In the mean time, if you, your family, or friends have any questions about financing residential or commercial real estate, please call or email me.  Here are today's rates.  Cheers!  E

Eric Grathwol

Loan Officer

Priority 1st Mortgage

3300 Douglas Blvd. Ste. 270

Roseville, CA 95661

direct: 916-223-4235

office: 866-771-9000

fax: 916-771-9099

www.priority1stmortgage.com

egrathwol@priority1stmortgage.com

May 27, 2009

"As we know, there are known knowns. There are things we know we know. We also know there are known unknowns. That is to say we know there are some things we do not know.  But there are also unknown unknowns, the ones we don't know we don't know." - Donald Rumsfeld, 2002

He might have been on to something.  And, after today's market activity, where fixed rates jumped about .375% higher, and ARM and Jumbo rates barely moved, I think it's pretty clear, his point can be well taken in the world of economics, too.

Some of our known knowns include:

• We know we've been through the bursting of both the housing and credit market bubbles
• We know that economic growth has been dealt a severe blow, both domestically and across the globe
• We know that unemployment is around 9% nationally, and if you count the "under employed" that's closer to 15%
• We know that the United States has just moved through the largest era of consumption ever, highlighted by a negative savings rate (where consumption drove over 70% of our Gross Domestic Product) to what appears to be a more frugal lifestyle, with savings rates rising back to the 5%+ range.
• We know the US and global economies will recover, at some point

Things we know, we don't know, include:

• We know we don't know whether this recession will mirror previous recessions and whether milestones we think we've seen before signal specific turning points, similar to those of previous economic cycles, or if they're just markers on a new road
• We know we don't know whether US consumption can resume and/or continue as the driver for world economic growth
• We know we don't know whether the massive amounts of money the US - and other economies around the globe - are pumping into the system (and financing) will lead to hyper inflation, or whether the deflationary pressures of two popping bubbles will keep that at bay
• We know we don't know exactly when, and how the US and global economies will recover, nor do we know what that will look like

Lastly, the unknown unknowns include:

• Well, if I could list them, they wouldn't be unknown, would they?  But, we can speculate...

So, why did we see such a knee jerk reaction in the Mortgage Backed Securities market today?  Was it in fact knee jerk, or prescient moves by investors?  Did anything fundamentally change in our economic picture?

If you've been paying attention, you've noticed that Treasury yields have been steadily rising for the last several weeks, while mortgage rates have remained at historic lows.  So what happened today?

It really boils down to the same two drivers of mortgage rates, inflation (or fears of inflation) and supply/demand.

Investors (and remember, it's just investors who set mortgage rates) fear that the ongoing economic stimuli and burgeoning defecits will lead to inflationary pressures (some people even think Zimbabwe-like inflation of 1000s of percent).  They feel - and there's data to support - that the deflationary impact of the credit and housing implosions have been muted.  So, when all the stimuli take hold, we could overly hot inflation, if not outright hyper inflation.  Since that erodes the long-term return of a fixed investment, they want to charge more up front.

These investors are also concerned that as the US continues issuing Treasuries and Government Bonds in unprecedented quantities to finance our spending, buyers' appetite for those bonds will wane, despite very strong participation in recent Treasury auctions, so yields will need to rise further to entice continued investment.  That would mean higher mortgage rates, too.

And lastly, there's discussion/rumors that much like the UK is facing possible credit downgrades, the US may lose it's AAA credit rating, which would certainly drive Treasury yields, and mortgage rates higher.

Whether any of that will actually happen, I'd call a known unknown.  But, markets like to react that way - as a hedge.

So what will the Fed do?  As I've been reporting, their purchases of Mortgage Backed Securities have focused on coupons between 4.5% and 5.5%, which translates into loans with rates in the 5.5% to 6.5% range.  Will they now dive into buying MBS in the 3% to 4% range to spur that market along?  Will it work?  We'll see.

Whether they do or not, will depend on how they read their tea leaves and evaluate their known knowns, known unknowns and unknown unknowns. 

Either way, I believe that although our economy may show signs of recovery in the second half of this year, we're in a pretty protracted economic downturn, which is likely to depress stock market gains for some time.  That's good for lower interest rates because they can provide a less risky, and more stable return.  Meanwhile, since there's such an overhang of supply and capacity in pretty much every economic sector, more companies will continue to go away as their sales will not support their bottom line.  And lastly, as the US Consumer continues to retrench, we'll likely retreat from driving over 70% of GDP back down to the mid 60%'s.  To me, that all spells long contraction and slow recovery.  As such, I really do think mortgage rates are likely to stay pretty low for some time (some time being 6-12 more months).

But, that spike we saw today - whether by gradual progression, or sudden fits and spurts- will eventually happen.  And, it's unrealistic to think that there's no horizon to the sub 5% (and even sub 6%) mortgage rates we're growing accustomed to.

So, as I always say, if everything has lined up for you, it's always good to take a bird in the hand.  You never know how long it'll be there.

And that's my two cents.  As always, if you, your family, or friends have any questions about financing residential or commercial real estate, please call or email me.  Here are your rates for the rest of this week.  Cheers!  E

Eric Grathwol

Loan Officer

Priority 1st Mortgage

3300 Douglas Blvd. Ste. 270

Roseville, CA 95661

direct: 916-223-4235

office: 866-771-9000

fax: 916-771-9099

www.priority1stmortgage.com

egrathwol@priority1stmortgage.com

May 1, 2009

What does the movie Caddyshack have to do with today's economic outlook?

Be the ball, Danny.  Be the ball.

Caddyshack is one of my all-time favorite movies.  I often say that everything we need to know in life can be seen and learned in Caddyshack.  As Ty tells Danny, so famously "Be the ball, Danny.  Be the ball."  His message is clear.  You have to see your goal, and believe you can achieve that goal, for it to materialize.

Napoleon Hill was one of the first modern writers to capture that philosophy on paper, in his book Think and Grow Rich.  Tony Robbins has built a huge business espousing the same core beliefs.

And now, that's exactly what the Obama Administration, Treasury Secretary Geithner, and Fed Chairman Ben Bernanke are doing.  They're talking positive about our economic outlook.  Or at least they're being less negative.

Now don't get me wrong.  You can't just "be the ball" in thought, without following through with actions, and expect great results.  But... there's little doubt the actions of the Fed and Treasury are taking hold.  Money is flowing freely, and cheaply to strong borrowers.  They're pumping trillions of dollars into our economic engine to lube the gears that had nearly ground to a halt.  And, they reserve the right to implement additional measures as needed to reflate our economy.  Our economy will recover.

However, just like it took years for the housing and credit bubbles to inflate and then burst, resuscitating our economy is a process that will take time, too.  Some of the more astute analysts I read think it'll be a few years of slow, below trend growth before our economic engine is humming along again.  I can't disagree.  If we resume trend growth sooner, that's a bonus.

And, that's the trick.  During that slow-growth (or no-growth) period, people may find it hard to believe in our economic recovery until they feel the turn in their own fortunes.  It will happen, but it will be a process.  And, if people don't believe it's going to happen, that their situation will improve, they'll retrench further, which could work to spiral back the other way, since nearly 70% of our economic growth depends on consumer spending.

So, to prime the pump we're hearing about "green shoots" of economic growth.  In the FOMC (Federal Open Market Committee) meeting statement released this week, the Fed stated "The economy continued to contract, though the pace of contraction appears to be somewhat slower."  The President's tone has changed too.  He's now more focused on the "Can Do" American ethos that got us to the Moon, than highlighting the economic pitfalls we still face.

So, will the positive talk work?  It definitely won't hurt.  But, we have to look beyond the talking heads.

We can see the rise in the stock market over the past 8 weeks, which pretty much coincides with the turn to more positive talk from the White House, Treasury, Fed, as well as CEOs of financial and other companies.  And, I agree in the tactic.  Positive thinking breeds positive results.  But, as we look for opportunities we need to be wary of some realities too, that can impact our decisions, and personal wealth.  We cannot afford to bury our heads in the sand.

The stock market has risen because companies are now exceeding analysts' expectations.  But, those expectations have been pretty low.  And, we could be in a period of low expectations with chronic bouts of underachieving even those lowered expectations.

As Nouriel Roubini, Economics professor at NYU and Chairman of RGE Monitor points out in a recent writing about our financial sector: "In brief, banks are benefiting from close to zero borrowing costs and fewer competitors; they are benefiting from a massive transfer of wealth from savers to borrowers given a dozen different government bailout and subsidy programs for the financial system; they are not properly provisioning/reserving for massive future loan losses; they are not properly marking down current losses from loans in delinquency; they are using the recent mark-to-market accounting changes by FASB to inflate the value of many assets; they are using a number of accounting tricks to minimize reported losses and maximize reported earnings; the Treasury is using a stress scenario for the stress tests that is not a true stress scenario as actual data are already running worse than the worst case scenario." (RGE Monitor)

That's a pretty sobering assessment.  And, since credit is truly the lubricant of our economy, our financial institutions' viability is critical to returning our economy to trend growth.  We'll hear the results of the recent Stress Tests next Thursday, May 7.  It'll be interesting to hear that assessment of our financial institutions.

Then we have the US Consumer.  Personal savings rates are at a recent high, hitting more than 4% last month.  That's great for individuals, and should be encouraged, but...a penny saved is a penny not spent.  Since our economy is so dependent upon Consumer Spending to drive growth, if we're spending less, our economy will likely grow less.  Additionally, the ATM that many people tapped through Mortgage Equity Withdrawals (MEW) has shut down. 

It's rare that I'm seeing "cash out" refinances now, although I'm seeing a TON of rate/term refinances.  People are seizing these historically low rates and yielding some significant savings.  But, it appears most of them are using that mortgage payment savings to either build their retirement, or pay down other debt.  Most of it doesn't seem to be trickling back into the economy.  That lack of MEW will put a further drain on consumer spending.

Meanwhile unemployment is likely to remain high for some time.  Layoffs, and subsequent re-staffing, are typically lagging economic indicators.  As companies sell less, they try to cut costs, they lay people off as part of that process.  So far, it appears the pace of layoffs is slowing - which is indeed a good sign - but, companies are still handing out pink slips.  I have an Uncle and a close friend who both recently lost jobs.  As people lose jobs, or fear they may, they too will cut back on their spending.  As they spend less, companies sell less, so...they lay off more people to cut more costs.  It's a cycle that only turns around when over supply is whittled down, and demand picks up, so companies can staff up to produce more.

The combined bubble bursts of the housing and credit markets have brought to close an era of massive, unprecedented consumption and over capacity.  That's probably going to take some time to soak up.

Then, there's the Commercial Mortgage Market.  As you've heard me say, I believe this to be another big shoe that's yet to drop.  Or, one that's now starting to drop.  Two weeks ago, General Growth Properties, America's second largest mall owner, filed for Chapter 11 Bankruptcy.  That's likely the tip of the iceberg of commercial defaults. 

And, commercial lending accounts for roughly 22% of American bank loans.  Foresight Analytics, a research firm, reckons that $594 billion of commercial mortgages will mature in America alone between 2009 and 2011.  Not all of those were collateralized, but the majority certainly was.  Richard Parkus, a Deutsche Bank analyst, estimates that some 70% of Commercial Mortgage Backed Securities will not be able to be refinanced, unless debtors bring significant additional capital to the table, due to lost equity, and more stringent underwriting guidelines in place now, relative to those loans' origination. (The Economist, 4/23/09). 

Now, take that number, and ratchet it up by the same levels of leverage we saw for Residential Mortgage Backed Securities.  It's pretty staggering.

I hope that level of defaults was used in the Stress Tests performed on 19 of our largest financial institutions.  Unfortunately, I fear the Stress Tests - like our government's growth projections - may have been a little on the rosy side.  After all, it's hard to Be The Ball.

So, what does this mean?

Basically, yes, we may have moved through the sharpest period of decline in this recession.  But, I say that cautiously.  Q3 and Q4 2009 could prove that another down leg was still out there.  Even if we don't see another precipitous drop in economic activity like the -6.1% GDP of Q1 2009, I think it'll still be negative growth.  That's contrary to what a lot of analysts and certainly our government projects.

But, I do think we're in for an extended malaise.  So, tread carefully.  There are definitely opportunities out there, whether in real estate, private debt markets, equity markets or other investment vehicles.  The trick is to know your horizon, know your risk/reward threshold, and most importantly to make sure that a bad decision doesn't risk costing you everything.

And, for first-time and move-up homebuyers, this is a great time to evaluate your options.  I'm sure there will be many people who will sit on the sidelines too long, and be kicking themselves down the road for doing so.  But, that's the trick about "finding the bottom."  We'll know it 6 months after it's gone.

Be the ball.

As always, call or email if you or anyone you know has questions about financing residential or commercial real estate.  Here are your current rates.  Cheers!  E

Eric Grathwol

Loan Officer

Priority 1st Mortgage

3300 Douglas Blvd. Ste. 270

Roseville, CA 95661

direct: 916-223-4235

office: 866-771-9000

fax: 916-771-9099

www.priority1stmortgage.com

egrathwol@priority1stmortgage.com

March 17, 2009

Well, it's been a month since my last update.  Not because there hasn't been any news about the economy, bail outs, etc. but really in spite of that, mortgage rates have clung to this 5% range (4.875%-5.125% for 30yr fixed money).

Despite the stock market finding a new floor, blowing past the previous lows of November 2008 - just days after my last update - mortgage rates didn't really improve much.  Likewise, they didn't really worsen as the stock market rallied last week.

The reason rates didn't change much boils primarily back down to the two main drivers of interest rates:

1) Supply/Demand

2) Inflation, or fear of it, eroding the return of that fixed investment

So, yes, although money was pouring out of equities during the market's most recent nose dive, and being parked in bonds and mortgage backed securities, there's just so much volume of new bond issuances (less so, certainly with mortgages) that prices really didn't rise, pushing yields lower.  In fact, since the New Year, bond yields have actually risen (meaning prices have fallen) significantly.

What has kept mortgage rates from rising back up to the 6% range has primarily hinged upon the Fed's program of purchasing Mortgage Backed Securities.  They're soaking up a lot of the supply, keeping rates from rising.  Right now, that plan is set to expire in June.

I'm betting that in tomorrow's FOMC policy statement they'll either extend that program outright, or at least hint that's a possibility.

That's one dynamic, covering the supply/demand side of mortgage rates.

The other dynamic is that investors fear that all the new money flooding the system in an effort to reflate our economy, will lead to inflation down the road.  Since our mortgage rates are fixed for 30yr years - primarily - it doesn't matter to an investor when inflation hits.  It's a matter of how hard and for how long.  Most economists believe we'll return to growth some time in late 2009 or 2010.  That growth can lead to inflation. (Other economists think we'll be in a long period of cyclical deflation, but...that's another story).  A little inflation will be welcome, but...too much, and there's a problem.

I believe it's those factors that are primarily keeping rates around 5%.  And, that's still great!

Now, let's look at what can move those rates higher or lower as we move into Q2 09.  It's going to be the same two factors, of course.

On the supply side, the Fed has to keep issuing bonds and growing its balance sheet to pay for the bailouts, budget proposals and ensuing deficits, etc.  Who's going to buy them?

Remember that song, Chi-ina Chi-ina?  That's who. Primarily, at least.

China is far and away the biggest holder of US debt.  They have currency reserves of roughly $2 Trillion, 60% of which is in US assets.  China's top banking regulator said recently the country will pay attention to safety, liquidity and profitability when deciding whether to buy more U.S. debt.  "How much we will invest in U.S. Treasuries will depend on the three elements," said China Banking Regulatory Commission Chairman Liu Mingkang at a press conference in Beijing. (Bloomberg.com 2/26/09).

As long as China is willing to step up to the plate - and they kind of have to b/c we buy all their goods - that will help finance our bond issuance, and help to keep rates in their current range.  However, if they stopped buying so much of our debt, rates would have to rise quickly in order to entice them, or other investors, back to the table.  But, unless that happens, despite the Fed having discussed buying its own bonds and treasuries on three occasions since December 1, 2008, I expect they'll continue holding off. 

Here's a recent statement to illustrate:  "At this point in time, the Fed has judged that buying long-term Treasuries is not the most efficient means of easing financial conditions," Federal Reserve Bank of New York President William Dudley said after a March 6 speech in New York.  (3/16/09 Rich Miller, Bloomberg.com)

Here's another perspective from Korea:  "The U.S. is borrowing so much that it may have trouble paying the money back," said Jaemin Cheong, a bond trader in Seoul at Industrial Bank of Korea, the nation's largest lender to small- and mid-sized companies.  "Yields are headed higher," Cheong said in an interview. "More issuance will be needed to support the economy. The possibility of default is more and more as time passes."  

So, it's my contention that the Fed will only step in and directly purchase US bonds, treasuries etc. IF foreign demand wanes.  Should that demand hold up, then the Fed will continue keeping its focus on other tactics.

Having said that, Fed Chairman Ben Bernanke's former colleague (they shared an office wall way back when) is implementing a treasury purchase program in Great Britain.  How their policy plays out could impact Chairman Bernanke's ideas on the subject.  At this point in time, everything is fluid as they use different tools and evaluate each measure's impact.

But, unless and until either the Fed starts buying more bonds, soaking up that supply OR we see another precipitous drop in equities creating a "flight to safety" - which can certainly happen given the economic headwinds we face - I don't see mortgage rates moving much lower than today's levels.

On the housing front, it's really more of the same, too.

Nationally, Moody's Economy.com says that of the nearly 52 million U.S. homeowners with mortgages, about 13.8 million, or nearly 27 percent, owe more than their homes are worth after many months of declining prices. 

California had 1.9 million borrowers with negative equity at year-end, more than any other state, followed by Florida's 1.28 million. About three in 10 borrowers in both states were underwater. (Jonathan Stempel, Reuters 3/4).

I read today that some experts are forecasting a full 50% of homes with mortgages will be underwater by year's end.

The administration, launching what it calls the "Making Home Affordable" initiative, said that borrowers seeking loan modifications will have to provide their most recent tax return and two pay stubs, as well as an "affidavit of financial hardship" to qualify for the $75 billion loan modification program, which runs through 2012.  Borrowers are only allowed to have their loans modified once, and the program only applies for loans made on Jan. 1 2009 or earlier. Up to 4 million borrowers are expected to qualify. Mortgages for single-family properties that are worth more than $729,750 are excluded.

Separately, up to 5 million borrowers who have mortgages held by government controlled mortgage finance giants Fannie Mae and Freddie Mac should be eligible to refinance through June 2010. (AP 3/4/09)

However, there still is no true remedy for homeowners who are more than 5% upside down.  Again, I think by the end of this year we'll be hearing about wholesale debt forgiveness.  As hard as that pill may be for some of us to swallow, it may be a necessary step to stem the tide of ongoing foreclosures.  Time will tell.

Despite all that, we will get through this.  You hear me say it time and time again.  For those who are well positioned right now, there are some phenomenal opportunities.  I hope you're in a position to seize them.

As always, call or email if you or anyone you know has questions about financing residential or commercial real estate.  Here are your rates for this week.  Cheers!  E

Eric Grathwol

Loan Officer

Priority 1st Mortgage

3300 Douglas Blvd. Ste. 270

Roseville, CA 95661

direct: 916-223-4235

office: 866-771-9000

fax: 916-771-9099

www.priority1stmortgage.com

egrathwol@priority1stmortgage.com