John Herzog, Alabama's first Certified Mortgage Banker, is a finance wizard, world class trainer and friend of many years. He has always had the ability to take the most complex concept and restate it in terms that I and others can easily understand. 
 
And once again he's done it: an intelligible explanation for the current state of affairs in the world of high finance. Thanks, John!
 
"Trying to guess which way interest rates will go in circumstances unprecedented since the great depression is impossible so let's see if we can describe what is going on in laymen's terms to allow each of you to decide for yourself if the government is taking the right course of action.
 
Banks and investment banks have a lot of delinquent (and potentially delinquent) loans on their balance sheets. These financial institutions are required to hold money (capital) in reserve against the potential of the future losses of the bad loans to be considered solvent. The money held off the market then is lost to the market as capital for future lending. The higher the delinquencies the more capital held out of the market until finally there is no new money for new loans (lack of liquidity). That is about where we are as no new capital is flowing into the mortgage markets. 
 
Potential solution: Issue each of these institutions a Waste Away Bin with two wheels to roll it to the Wall Street curb. Allow them to put all their bad debt in the bin and put it on the curb for the government to come pick it up for some small percentage of its value. The money the government pays these institutions for their bad debt when they drive the garbage truck down Wall Street will be just enough to keep the institution afloat. The real value however will be to free all that capital being held in reserve against future losses to inject into the credit markets (all be it under much tighter credit guidelines and regulation).
 
Next the Federal Government takes all the garbage back to the dump and tries to make compost out of it so they can sell it later for more than they paid for it so the tax payer does not lose money. It remains to be seen if this step could be accomplished, but it is believed the losses will not be as great as the market currently expects and consequently later the value of these bad assets will rise.

 

Sounds like a good solution, but there are a lot of variables that will determine if in fact it will work:

 
1. Will the cost of buying the bad assets drive the dollar down, cause inflation to go up, and make rates rise?
 
2. Will lenders find enough "qualified" borrowers for their new money under the tighter regulations to stimulate the housing market back into prosperity and avoid recession?

 

3. Will the government be able to work with the troubled assets (loans) it buys enough to resell them at a profit, or will this "bail out" cost the taxpayer a bundle and be a drag on the economy for decades? 
To use Barak Obama's phrase, the answers to these questions are above my pay grade and I am glad some of the best financial minds in America are focused on the problem. For me, I am betting they'll work it out."

 
John Herzog CMB
Vice President/Regional Manager
New South Federal Savings Bank

Mortgage Market in Review
Week of September 22, 2008                                       Volume 15, Issue 39

Market Comment
Mortgage bond prices rose last week applying a slight downward pressure on mortgage rates. Trading in the financial markets remained in disarray. The Dow Jones index moved more than 400 points, both up and down, several times during the week. Rates fell sharply early in the week as traders fled stocks for the safety of bonds. This money flow reversed Thursday afternoon after rumors of a massive government intervention into the financial markets surfaced.
 
For the week, interest rates on government and conventional loans fell by about 1/8 of a discount point.
 
Durable goods orders and new home sales data will be the most important events this week. The mortgage interest rate market remains volatile as US Government officials strive to bring liquidity to the financial markets.
Looking Ahead
Economic
Indicator
Release
Date and Time
Consensus
Estimate
 
Analysis
Existing Home Sales
Wednesday, Sept. 24,
10:00 am, et
Down 1.4%
Low importance. An indication of mortgage credit demand. A significant decrease may lead to lower rates.
Durable Goods Orders
Thursday, Sept. 25,
8:30 am, et
Down 1.3%
Important. An indication of the demand for “big ticket” items. A larger than expected decrease may lead to lower rates.
New Home Sales
Thursday, Sept. 25,
10:00 am, et
Up 0.5%
Important. An indication of economic strength and credit demand. Weakness may lead to lower rates.
Q2 GDP final revision
Friday, Sept. 26,
8:30 am, et
Up 3.4%
Very important. The aggregate measure of US economic production. Weakness may lead to lower rates.
U of Michigan Consumer Sentiment
Friday, Sept. 26,
10:00 am, et
None
Important. An indication of consumers’ willingness to spend. Weakness may lead to lower mortgage rates.


Durable Goods Orders
Durable goods orders are generally believed to be a precursor of activity in the manufacturing sector because manufacturing must have an order before considering an increase in production. Conversely, a decrease in orders eventually causes production to be scaled back; otherwise the manufacturer accumulates inventories, which must be financed.
 
Unfortunately, durable goods orders data has many drawbacks. The first problem with the orders data is that they are extremely volatile. The volatility of the data usually is attributed to the civilian aircraft and defense components of the figure. For example, if Boeing has a big order for one of its jumbo jets, the civilian aircraft category can change by $3-4 billion. The same scenario is evident when an aircraft carrier is ordered, surges in the defense category result. Keep this in mind with the current economic environment. Many sectors of the economy continue to struggle, but defense spending remains robust.
 
The second problem with the data is that orders are continuously being revised. There are many times in the past when the advance report on durables showed an increase while a revision a week later showed a decrease. The revised data is found in the report on manufacturing orders, shipments, and inventories. 
 
Since the data is very volatile and difficult to forecast, there is quite often a huge disparity between the actual release and the initial projections.   If the durable goods report is much stronger than expected, look for mortgage interest rates to push higher. If favorable, the data may help interest rates remain steady or even push lower.