The Maestro’s latest prediction

Apparently Alan Greenspan wrote in an article for Emerging Markets Magazine that home prices would begin to stabilize in the early part of 2009.  Specifically, “More conclusive signs of pending home price stability are likely to become visible in the first half of 2009.

Although many of the prophetic statements he has made in the past have failed to come to fruition maybe this could be an exception.  I personally tend to agree with him but I also think homes prices will remain low for another 12 months before any sign of widespread appreciation are evident.

Deleveraging is the word of the year

The Economist featured this great article today about the fact that not only financial firms but businesses and individual households will be forced to deleverage over the course of the next few years.

Among the points that I found interest in:

*In the near term delveraging of banks, hedge funds, and households will likely depress asset prices lower.  This is because as people sell assets to pay-off debt (deleverage) they will increase the supply of assets in the marketplace.

*Even if the bailout plan goes through the financial industry will likely suffer for sometime making credit harder to come by.

*Thanks to the impact of devleveraging, “a shortfall of bank capital of around $170 million may reduce the potential supply of credit by $1.7 trillion.”

*”Morgan Stanley reckons that total American debt (ie, the gross debt of households, companies and the government) has risen inexorably since 1980 to more than 300% of GDP (see chart), higher than it was in the Depression.”

Main points of government intervention

Treasury Secretary Henry Paulson made it public this morning (this news had leaked yesterday afternoon causing stocks to rally in late trading) that the government would intervene in the financial markets to shore up confidence in the financial system.

According the Wall Street Journal the government’s intervention could become “the largest intervention in the financial markets since the 1930s.”  This is great news as the health of the financial system was being called into question over the past couple days.

In fact, over the past two days $180 billion has been taken out of traditionally safe money market funds because of fear that the assets backing the fund would fall below the value of the deposits.  This led to investors buying short-term treasury securities with a NEGATIVE RETURN (meaning these investors were willing to accept less money than the money they were investing for the safety of the US government).

Among the measures that the Treasury Secretary announced this morning were-

*Increase the government’s purchases of mortgage backed securities.

*Acquire “bad assets” (risky mortgage-backed bonds) from financial institutions so they can remove them form their balance sheet.

*Ban investors from “short-selling” the stocks of 799 vulnerable financial institutions.

It is unclear what this new intervention will look like in terms of the organizational structure but more details should become available early next week.

Short-term treasuries move to negative return

In probably the most telling sign that the financial markets are a mess yields on short-term treasuries actually turned negative yesterday. reported on this phenomenon in this article.

* “The desperation was especially striking in the market for U.S. government debt, long considered the safest of investments. At one point during the day, investors were willing to pay more for one-month Treasurys than they could expect to get back when the bonds matured. Some investors, in essence, had decided that a small but known loss was better than the uncertainty connected to any other type of investment.

That’s never happened before. In a special government auction on Wednesday, demand ran so high that the Treasury Department sold $40 billion in bills, far beyond what it needed to cover the government’s obligations.” crisis since Great Depression featured a great article summarizing the problems we find ourselves in.  You may access the article by clicking this link.

Among the points that I found interesting-

* “This has been the worst financial crisis since the Great Depression. There is no question about it,” said Mark Gertler, a New York University economist who worked with fellow academic Ben Bernanke, now the Federal Reserve chairman, to explain how financial turmoil can infect the overall economy. “But at the same time we have the policy mechanisms in place fighting it, which is something we didn’t have during the Great Depression.”

* Fed and Treasury officials have identified the disease. It’s called deleveraging, or the unwinding of debt. During the credit boom, financial institutions and American households took on too much debt. Between 2002 and 2006, household borrowing grew at an average annual rate of 11%, far outpacing overall economic growth. Borrowing by financial institutions grew by a 10% annualized rate. Now many of those borrowers can’t pay back the loans, a problem that is exacerbated by the collapse in housing prices. They need to reduce their dependence on borrowed money, a painful and drawn-out process that can choke off credit and economic growth.

* At least three things need to happen to bring the deleveraging process to an end, and they’re hard to do at once. Financial institutions and others need to fess up to their mistakes by selling or writing down the value of distressed assets they bought with borrowed money. They need to pay off debt. Finally, they need to rebuild their capital cushions, which have been eroded by losses on those distressed assets.

* Today, Mr. Bernanke is taking out his playbook, said NYU economist Mr. Gertler, “and rewriting it as we go.”

* The latest trouble spot is an area called credit-default swaps, which are private contracts that let firms trade bets on whether a borrower is going to default. When a default occurs, one party pays off the other. The value of the swaps rise and fall as the market reassesses the risk that a company won’t be able to honor its obligations. Firms use these instruments both as insurance — to hedge their exposures to risk — and to wager on the health of other companies. There are now credit-default swaps on more than $62 trillion in debt, up from about $144 billion a decade ago.

Rate Update September 16, 2008

Rates are effectively unchanged this morning.

There is A LOT to talk about this morning as crisis in the financial markets persists. Here is a summary of the major stories we’re falling that are likely to impact the direction of mortgage rates:

→ AIG: The nation’s largest insurer is close to insolvency. Analysts are suggesting that the troubled insurer needs to raise $75 billion in fresh capital to stay afloat. The failure of this firm would be unprecedented because of it’s vast reach & volume of obligations. AIG operates in 130 countries and is a major player in the credit default & life insurance sector. AIG’s failure would likely cause a major disruption in the financial markets which could drag other firms down with it. Although rates may benefit from this news in the near term, in the long run this would be a disaster.

→ Federal Funds Rate: The Fed is scheduled to announce their interest rate policy decision this afternoon. Last week at this time there was a 0% chance that the Fed would alter rates. However, analysts now assume a cut of at least .25% and possibly even .50%. Remember that in and of itself the Fed cutting rates will not directly impact mortgage rates. However, what they say following their announcement can.

→ Consumer Price Index: Finally, the Labor Department released the monthly CPI report. The report came in line with expectations reflecting a 5.4% increase year-over-year. When stripping out volatile food and energy prices year-over-year inflation rose by 2.5%. Although these figures are relatively high compared to the past couple years the announcement did not surprise the markets.

Current Outlook: floating