Volume 12 Issue 12
December 2007

By:
U.S. Senator John Seymour (ret.)

NATIONAL ECONOMY: The revised Gross Domestic Product (GDP) for the third quarter came in at a surprisingly strong 4.9%. That compares to the 3.9% original estimate. However, most estimates call for a distinct slowing of GDP in the 4th quarter to 1.5%. Consumer spending, which historically accounts for two-thirds of our GDP, grew at a 2.7% rate during the third quarter. That compares to a 1.4% growth in consumer spending during the second quarter of this year. Initial reports on holiday spending estimate about a 3% increase in retail sales compared to one year ago. Inflation remains subdued with a 1.8% increase in "core" prices for the third quarter. Core prices exclude volatile energy and food costs. Although November new employment numbers were not available for this printing, expectations are for sluggish but steady new job growth and stable unemployment. The very volatile credit and mortgage markets plus the continuing slide in the housing market have created a fall in consumer confidence and rightful concern about a possible recession. It is too soon to tell with any certainty; however, I believe that if we find the bottom in the sub-prime mess within the next ninety days, the credit markets will stabilize and our economy will have dodged the recession bullet.

THE FED WATCH & MORTGAGE RATES: I reported last month that FED Chairman, Ben Bernanke, would push to open up and make more transparent to the public, the FED's policies, forecasts and decision making processes. True to his word, Bernanke has done just that. In their quarterly economic forecast, the FED believes that GDP growth will be 2.4% to 2.5% this year. For 2008, they project a growth rate of 1.8% to 2.5%. For 2009 and 2010 they are predicting GDP growth of 2.3% to 2.7%. For the entire period of 2007 to 2010, they are projecting unemployment at 4.7% to 4.9%. Core inflation is estimated to be 1.6% to 1.9%. Although there wasn't any "ground breaking" news in their forecast, it was like a breathe of fresh air compared to the "smoke & mirrors" style of Bernanke's predecessor, Alan "Guru" Greenspan. Ben and his boys next consider interest rates at their meeting scheduled for December 11th. As of today, Wall Street is betting that there is a 50-50 chance that the FED will reduce their Fed Funds rate to 4.25% on December 11th. My personal bet is that they will cut rates again. The recent upheaval in the credit markets following the August debacle has created such uncertainty, the FED must do all that it can to restore stability, and another rate cut will temporarily provide that stability. When Citicorp has to get a $7.5 billion capital infusion and pay 11% to get it, and Freddie Mac has to raise capital through a preferred stock offering, you know there are big troubles on Wall Street. Bernanke cannot ignore the call. Mortgage rates will begin a slow rise within the next 30 days. Despite the 10-year treasury notes hovering around 4% and historically the 30 year fixed-rate mortgage rate running about 2% higher, right now other dynamics are in play that I believe will translate into increasing mortgage rates by 25 to 50 basis points. Specifically, 90% of the mortgage loans originated today are being sold to either Fannie Mae or Freddie Mac. Without a securitized mortgage market, Fannie & Freddie are the only game in town. Today, Fannie & Freddie gave notification that effective March 1, 2008, they will be implementing new risk-based pricing adjustments on all loans they buy with Loan To Value ratios above 70% made to borrowers with credit scores of less than 680. The pricing adjustments will range from, 0.750 to 2.000, depending upon the credit score. Unless the credit markets loosen up and provide some competition for Fannie & Freddie, the duopoly will have their sway and in effect raise mortgage rates. Bernanke, in testifying before a congressional committee, floated the idea that since there is little to no market for "jumbo" mortgage loans, those loans above $417,000, that Fannie & Freddie be permitted to buy them. California, with its median sales price at roughly $500,000, is in dire need of a "jumbo" loan market. However, the Bush Administration turned a cold shoulder to Bernanke's brainstorm and with congress's historical bias against the Golden State, I wouldn't hold my breath waiting for that change. The first "shoe to drop" was the fraudulent and speculator sub-prime loans made without loan documentation and no equity into the deal. By the end of this month, most lenders will have disgorged those foreclosed properties onto the market. But, hold your hat…the other shoe is about to drop in the form of an estimated $362 Billion of adjustable rate loans. Most of these loans were originated in late 2005 through early 2007 period. Most of these loans are ready to "reset" the mortgage rate and therefore raise the borrowers monthly payment. Although, no credible source has estimated how many of these loans will potentially default and end up in foreclosure, a growing number of political voices and consumer oriented non-profit groups are demanding that lenders of these loans postpone any rate increases or convert the adjustable rate loan to a fixed rate loan at the lower interest rate. Although I would be the first to agree that, in many cases, it is better for the lender to agree to renegotiate the terms of a loan or agree to a short sale than to foreclose on a property; however, it is absolutely appalling to me that anyone would suggest that a lender should rewrite a mortgage loan that has yet to default. Clearly, the lenders have become the ogre in this sub-prime mess and a few of them deserve it; however, the vast majority of mortgage lenders and brokers haven't done anything immoral, unethical, or illegal. The borrowers who sought these sub-prime loans believed that there was no end to the ever escalating housing prices and willingly took that gamble. It never ceases to amaze me how quick some people are to tell others what they should do with their money.

POLITICS & REAL ESTATE: The first of the legislative answers to the sub-prime mess has cleared the House of Representatives. Congressman Barney Frank (D) Mass, authored the Mortgage Reform & Anti-Predatory Lending Act of 2007, and the House passed the bill on a 291 to 127 vote. The bill would prohibit banks and loan securitizers from steering any consumer to a loan that the consumer lacks a reasonable ability to repay, does not provide a net tangible benefit, or has predatory characteristics. The bill should have been called The Anti-Homeownership and Trial Lawyers Dream Act of 2007. Should this bill become law, it will hurt the very people it portends to help. No lender in their right mind would take the legal risk of making a loan to any borrower who wasn't "gold plated." The loan securitizer is three steps removed from the borrower and can't possibly know what did or did not happen in the loan origination process. Therefore, the loan securitizer will refuse to buy any mortgage made to any low income buyer. I can understand Barney Frank authoring the bill, but those who voted for this piece of legislative garbage should be held accountable for their anti-homeownership vote. Someone should have told them what happened as a result of the Illinois State Legislature's attempt to similarly legislate the "Fairness In Lending Act of 2005." That state law tried to achieve similar goals in specific low income zip-code areas of Chicago. The result was a 45% fall in home sales in those zip-codes and a resulting plummeting of home values for those homeowners trapped with no financing available to sell their houses. Fortunately, in the Senate, Finance Committee Chairman Chris Dodd (D) Conn., has already indicated his opposition to Barney Frank's bill and I am sure that the Bush Administration would veto such a bill.

In every recent presidential election the issue of a "flat tax" is raised and then subsequently buried because all the versions of "flat tax" take away today's tax deductions that are important to one group or another. One of those groups are homeowners who would lose their mortgage interest, property tax, and mortgage insurance deductions in exchange for a flat tax. The total of these homeowner deductions is approximately $120 Billion per year. I believe that if the government were to eliminate these tax deductions, homeownership would lose much of its value and therefore home values would decline overnight and immediately. How much? I don't know, but I would guess about 10%. Republican Presidential candidate Fred Thompson has now suggested a "voluntary" flat tax. If the taxpayer wants the current system of deduction, they can opt to keep it. If the taxpayer wants a flat tax and is willing to give up their deductions, they can choose to do so. Sounds like a good idea to me; however, I must admit that every time politicians start fooling with the tax codes, I get nervous, because I remember the old adage, "Every person's tax loophole is another person's permitted tax deduction." I'm always skeptical that they are after my permitted tax deductions. Speaking of the 2008 elections, less than a year away, the Republicans in the House and Senate are in deep trouble. In the Senate, the Democrats have 49 seats, Republicans have 49 seats and Independents have 2 seats. The two Independents normally vote with the Democrats. In 2008, 6 Republican Senators compared to 2 Democrats are retiring. This means that the Republicans will have to defend the potential loss of a total of 23 seats while the Democrats will have to defend only 12 seats. The odds aren't good…In the House, fewer than 50 of the 435 seats are truly competitive races. The Republicans need to protect all of their seats plus pickup 32 of the 50 competitive seats. Not impossible, but likely improbable. A quick look at their financial war chests also is enlightening. In the House the Dems. Have $22.1 million on hand compared to the Reps. $1.6 million. In the Senate, the Dems. Have $20.6 million compared to the Reps $7.1 million. It's much to early to start to call the Presidential race, although in the Democratic primary, Hillary Clinton looks hard to beat. In the general election, a lot will depend on the state of the economy, the immigration issue, and the situation in the Middle East. As we get closer to November 2008, we'll take another look.

NATIONAL REAL ESTATE: Existing home sales eased 1.2% in October compared to the previous month and were down 20.7% from October of 2006. The national median price for an existing home was down 5.1% in October compared to one year ago. However, the drop in median price for October is distorted because of the lack of availability for "jumbo" real estate loans that slowed sales in the higher priced markets, like California. The unsold inventory of existing homes for sale rose 1.9% in October to a 10.8 months supply at the current sales pace. Regionally, sales were flat in the Northeast and South. In the Midwest, sales slipped 1.7% and in the West sales were off 4.4% compared to the previous month. New home sales improved 1.7% during October, but were down 23.5% from one year ago. Unsold inventories of new homes were down 2.3% in October compared to the previous month and represented an 8.5 months supply at the current sales pace. Homebuilders continue to reduce prices and offer a full array of buying incentives to move their unsold inventories. New single-family housing starts were down 7.3% during October and 25.1% compared to October of 2006. So far, in this housing down cycle, housing starts have fallen 48%. In previous housing down cycles, new starts fell 52% in '79-'80, 54% '64-'66, and 64% '73-'75. Before this down cycle is over, we might match the '79-'80 cycle, but I see little likelihood that we'll match the '73-'75 slide. Putting the sub-prime mess into perspective, we need to remind ourselves that the entire sub-prime market represents only 13.5% of the total mortgage market and the troubled sub-prime loans represent 20% of the entire sub-prime market. That means that only 3% of the entire mortgage market is in trouble. A recent study by the Joint Center for Housing Studies at Harvard University pointed out that the median net wealth for homeowners was $184,400 in 2004, 46 times greater than the median net wealth of renters at $4,000. Net household wealth nearly doubled from 1995 to 2005. It was $27.6 trillion in 1995, and rose to $51.8 trillion by 2005. 47% of the increase was a result of real estate ownership. A study by the Atlanta Federal Reserve Bank concluded that 70% of the increase in homeownership between 1994 and 2004 was because of the introduction of new mortgage products like sub-prime loans. With 20% of all sub-prime in trouble, 80% of those sub-prime borrowers have made it so far and most of them are first-time homebuyers. Congressman Barney Frank (D) Mass. wants to throw the baby out with the dirty dishwater.

CALIFORNIA ECONOMY & REAL ESTATE: The Golden State lost 15,800 jobs during October; however, the unemployment rate held steady at 5.6%. UCLA's Anderson School of Business forecast projects that California is in for at least another year of economic doldrums and slow job growth, but California will not sink into a recession. Unemployment is expected to peak at 5.9% and job growth for 2008 is expected to be 1%. UCLA Economist Ryan Ratcliff says that the end of 2007 will mark the peak of sub-prime, adjustable rate mortgage resets, and expects to see mortgage defaults peaking sometime in the first half of 2008.Existing home sales for Southern California were a mixed bag in October. Sales were down 20% in Los Angeles compared to September, down 11.3% in Orange County, up 16.4% in the Coachella Valley, up 15.6% in Riverside/San Bernardino and up 0.8% in San Diego, according to the California Association of Realtors (CAR). Clearly, sales activity is related to price. Year to date sales of existing homes below $500,000 are down 24.6%. Sales $500,000 to $999,999 are down 24.2% and sales above $1 million are down only 0.5%. CAR's Unsold Inventory Index rose to 16.3 months during October. Historically the highest Index recorded was in 1982 when we had a 22.5 months of unsold inventory. Median prices of single-family homes in Southern California are down 8% from one year ago. Regionally they are down in Riverside County by 15.1%, down 9.6% in San Bernardino County, down 8.2% in Orange County, down 6.1% in San Diego County ad down 3.8% in Los Angeles County. How bad are foreclosures? The average long run foreclosure rate has been 0.81% of all mortgage loans. Today it is 1.2%. Historically it has been higher, 1.5% to 2% in the '92 to '97 time frame. As this year comes to a close, I reflect on the fact that it has been a most challenging period for those in the housing and housing related businesses. I believe that we will hit the bottom of this cycle in the first quarter of 2008 and then slowly begin a recovery. Many of our associates and competitors will not survive, but for those professionals who have the courage and tenacity to see this through, this time next year, the outlook will be much brighter and those that have survived will be much stronger. My best wishes for a Merry Christmas and a Happy New Year!!!

DISCLAIMER: This newsletter is published by Orange Coast Title for the benefit of its customers and those of its affiliates, California Title, Advantage Title and Equity Title. The opinions expressed herein are solely those of the author and, are not in any way to be attributed to the employees or management of Orange Coast Title or their affiliates. Comments, criticism, or opposing views are always welcome at jfseymour@verizon.net.

SOURCES: LA Times, Wall Street Journal, Desert Sun, DQNews, OC Register, Sacramento Bee, San Diego Tribune, Inland Valley Bulletin, Barrons, Kiplinger California Letter, CAR, NAR, NAHB, BIA, and MBA.