Double Dip or Summer Doldrums? – Daily Mortgage Rate Update for July 16th, 2010

Inflation negligible; Bank revenues fall short; Consumers retreat; Impact of financial reform on the mortgage industry; Friday Effect should be in full swing today – Daily Mortgage Rate Update for July 16th, 2010

Stock markets opened sharply lower today and continued their fall on a mixture of factors. Overnight, megabanks Bank of America, Citigroup and JP Morgan Chase all reported their earnings. While their profits all came in higher than expected, gross income, or revenue, was lower than expected. This was widely attributed to the decline in stock market returns in the 2nd quarter, and the depressing effect that had on trading revenues at those banks.

Do you remember how big banks used to make money in the old days? They borrowed money through deposits, and lent out that money at a higher interest rate. Maybe they collected a fee or two on the loan, but mostly, they made money on the interest-rate spread.

The bottom line is that this is not happening. Banks are simply not lending money at the pace they did in the past for myriad reasons. First, credit risk is perceived to be higher, as job security is down, and collateral values and liquidity are sharply lower. Second, demand for loans is off somewhat, as Americans adjust to a more modest, lower-debt lifestyle. Third, banks have made some efforts to adjust their activities in anticipation of the financial reform package about to be signed into law, but fear over committing to adjust to regulations that likely won’t be fully implemented for as many as two years.

This is part of the reason that today’s inflation report, the Consumer Price Index, or CPI, was essentially flat. Inflation is important to mortgage rates, as too-high inflation will force the Federal Reserve to raise interest rates. Overall prices declined by 0.1%, while core inflation,  which excludes more volatile food and energy costs, was just 0.2% in the month of June. Follow me on this one:

• Inflation tracks changes in prices
• Prices tend to increase when there is more money in the economy
• Whenever a bank loans money, it increases the amount of money in the economy
• Therefore, fewer bank loans should lead to less inflation

Another factor keeping inflation low is the current unemployment level – more unemployed workers means less income, less spending and less inflation. One local bright spot this month is Rhode Island, where the unemployment rate declined by 0.3% to 12%. While this is still above the national average of 9.5%, it is a welcome improvement.

The University of Michigan’s Consumer Sentiment index was released this morning, and, as I predicted yesterday, was substantially lower than expected. Last month’s reading was 76, and economists had predicted that the index would come in at 74.5 this week. The actual result: 66.5, meaning that consumers are not pleased with the direction in which the economy is headed. Based on recent employment data and stock market activity, it was apparent that the consumer was going to take a step back this month. Consumer sentiment is very important to the economy, as roughly 70% of GDP is consumer activity.

In today’s Rumor Mill, let’s briefly discuss the newly passed, and soon-to-be-signed financial reform bill as it relates to mortgages. The most discussed feature of this 2300-page piece of legislation is how little consumers, and even lawmakers, know about it. The Dodd-Frank Wall Street Reform and Consumer Financial Protection Act has two main components, limiting excessively risky behavior on Wall Street, and creating a Bureau of Consumer Financial Protection to oversee a spectrum of financial products that consumers use. As it relates to mortgages, the BCFP would have the power to:

• Require lenders to verify borrowers’ ability to repay
• Prohibit pre-payment penalties
• Restrict some types of mortgage broker compensation

What is really happening here is the codification, or conversion into law, of practices that, for the most part, are already happening! Call your local mortgage broker, and ask if they can get you a stated income loan. It’s not out there. Pre-payment penalties only exist on home equity loans and lines of credit at this time. The biggest change would be to mortgage broker compensation, and the effect of this may be to limit interest rate options available to consumers. Because the bill would require broker compensation to come completely from the customer, or completely from the bank, but not a mix, brokers in the future might be able to offer interest rate options at 5.00% with points, or 5.5% without points, but nothing in between.

With all the bad news on the market today, the Friday Effect, a phenomenon in which traders seek to hold safer assets over a weekend, should be in full swing today. Pricing has already improved since markets opened, and I anticipate it will improve a little more towards closing time around 4:00. At present, the volume of negative data we’re receiving is enough to suggest that mortgage rates won’t be moving much higher any time soon, and may creep a little lower. I feel it is safe to float on loans closing anything more than 7 days from now. Next week’s data set is a bit lighter than this weeks, with standard weekly reports like unemployment claims and mortgage rates, but without heavy hitting reports like today’s inflation, or two-weeks-ago’s jobs data. The following week, we’ll get the all-important Advanced GDP reading for the 2nd quarter.

What’s really going on in the economy right now? There’s been plenty of discussion of the possibility of a “double dip” recession, but I’m not ready to buy that just yet. Rather, I think we may simply be seeing the combined effects of a pessimistic employment situation, in conjunction with a healthy dose of summer laziness. While there is significant economic data on the way, I doubt we’ll see any truly encouraging numbers until September or October. In the meantime, though, I don’t think we’re going to see any particularly depressing numbers either.

If you have questions regarding Rhode Island Refinance Rates, or whether or not to lock your loan, please don’t hesitate to contact me by cell at (401) 263-8655, or by commenting on this post. Have a great day!

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Dan Hartman is a Senior Mortgage Advisor with Province Mortgage Associates, and serves as an Adjunct Professor of Finance and Economics at Roger Williams University and the University of New Haven. He has been helping homeowners and homebuyers with their mortgage questions for over 10 years.

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