Market Update 09-23-2008

Today is not so much an update as an explanation.

US Stocks are finishing down for the day with the Dow off by over 150 points after experiencing triple digit gains earlier. Mortgage Bonds have also seesawed up and down throughout the day, and will finish negative though not by much.

There were no economic reports to look to for guidance by Stocks, but I doubt anyone would have paid attention as all eyes are on Capitol Hill watching for progress on the government's latest bailout. Investor's seemed frozen by uncertainty of what would come from Washington as Treasury Secretary Paulson, Fed Chairman Bernanke, and SEC Chief Christopher Cox faced questions on the details of their proposal. According to early press releases the Bush Administration, and congressional Democrats had come to agreement on the basics of a plan that would give Paulson authority to purchase as much as $700,000,000,000.00 (yes I'm going to keep writing it that way as a visual aid!) in bad mortgage debts "without limitation" for a 2 year period.

The theory is that these are bad mortgages because their Mark (value on paper as written) is considerably higher than their Market (what they could actually sell for today) value, and they are clogging up Bank's ability to lend. This is because the bank's are unwilling to write down the value from Mark to Market. As long as the bank holds the debt, the value of the debt (commonly referred to as the Note) does not decrease, and the loss in value only comes into play if it needs to be sold today, as in the case of foreclosure. As long as these debts are held by the bank in good standing, they are considered assets, and banks only need to keep a small percentage of assets (Capital, or Cash) versus investments. The inability to get these "assets" off their books at the value they are being counted as is where the system becomes "clogged." If the Bank is forced to sell them at their true Market value their asset base could fall below government mandated minimums, and they would face being taken over by the FDIC (IE - go out of business). If the Treasury is allowed to purchase those assets for close to their value on paper, bank's won't have to worry about coming up with the difference between the Mark, and Market values in the form of Capital in order to stay in business.

It all boils down to price. These mortgage debts have been "bundled" together (good and bad together), and sold as a "Mortgage Backed Securities" to investors who then service them, and collect the income stream from the interest on the outstanding debt. The problem facing the financial industry now is how to accurately value them. As Chairman Bernanke pointed out, there are no active buyers for these bundles due to fear of how many bad loans are in the bundle, and the result is two different prices: the fire-sale price, and the hold to maturity with all on time payments price the bank prefers. The bailout plan would allow the Treasury to buy these bundles from the banks at closer to the hold to maturity price which would give them the available capital to lend again, and "unfreeze" the credit market. This is what Bernanke meant when he said "Purchasing impaired assets will create liquidity and promote price discovery in the markets for these assets, while reducing investor uncertainty about the current value and prospects of financial institutions."

All of this was being questioned, and explained on Capitol Hill today, and the Markets were watching (remember those "uncertain investors"?). The Dow was swinging up and down by as much as 200 points in an hour, and Mortgage Bonds were acting in a similar fashion. In the end, it looks as though Congress is not excited about being rushed into action, and would prefer to get more details, while investors want to know whether or not the plan will be implemented.

Mortgage Bonds were only slightly negative at the end of the day, so rates should be roughly the same as they were yesterday, which is still pretty good. Until there is some resolution to this situation, the market will continue to be very volatile, and therefore unpredictable. I will continue to recommend locking for near term closings as the risk brought on by this chaotic environment could push rates the wrong way quickly.

Make it a great day!

Ron Brown

VA & FHA Loan Specialist

First Mortgage Company of Washington