Another record low of mortgage rates

The average interest rates on U.S. 30-year fixed-rate mortgages fell for a ninth consecutive week, reaching their lowest level in 37 years, according to a survey released on Wednesday by home funding company Freddie Mac.

Interest rates on the 30-year fixed-rate mortgage dropped to an average of 5.10 percent for the week ending Dec. 31, down from the previous week's 5.14 percent, Freddie Mac said. The 30-year fixed-rate mortgage has not been lower since Freddie Mac started the Primary Mortgage Market Survey in 1971.

Mortgage rates have dropped dramatically ever since the Federal Reserve unveiled a plan last month to buy up to $500 billion of mortgage securities backed by government-sponsored enterprises, Fannie Mae, Freddie Mac, and Ginnie Mae. The program also entails buying up to $100 billion of debt issued by Fannie Mae, Freddie Mac and the Federal Home Loan Banks. The Fed on Dec. 30 moved forward aggressively with an effort to drive down mortgage costs, setting a goal of buying $500 billion in mortgage-backed securities by mid-2009.

The housing market is in the worst downturn since the Great Depression as a huge supply of unsold homes, tighter lending standards and record foreclosures push down home prices. House prices fell 18% over the 12-month period ending in October, according to the S&P/Case-Shiller 20-city composite index. From its peak set in July 2006, the composite index is down 23.4%

An improvement in the housing market could portend a turnaround for the world's largest economy, which has been in a recession since late last year. The battered housing market is critical to the U.S. economy.

Consumer Confidence at the Lowest Level

The Conference Board's Consumer Confidence Index fell to an all-time low of 38 in December from a revised 44.7 in November. The record drop reflects the worsening U.S. economy, raising unemployment, deteriorating housing market, falling stock markets, and uncertain outlook for the New Year.

The gloomy job market and falling asset prices appear to have outweighed declining consumer prices in consumers' minds. Layoffs and income cuts were widespread this year. The unemployment rate has crept up to 6.7 percent in November, the highest jobless rate in the past 15 year. The number of Americans filing for first-time unemployment benefits rose to a 26-year high for the week ended Dec. 20.

The dismal news came at the end of a full year of recession. During the year the credit crunch has strained the financial system as central banks struggle to raise capital. Meanwhile, S&P 500 index has plummeted more than 40 percent and housing prices have plunged 18 percent on year to year basis in October.

Mortgage rate at 37-year low

Interest rates for the benchmark 30-year fixed-rate mortgage tumbled to a national average 5.17 percent this week, the lowest level since Freddie Mac began its weekly rate survey in 1971. The decline was supported by the Federal Reserve announcement on Dec. 16, when it cut the federal funds target rate to a record low, a range of zero to 0.25 percent, and stated it stood ready to expand its purchases of mortgage-related assets as conditions warrant.

The 30-year fixed-rate mortgage fell for the seventh consecutive week, dropping from 5.47 percent a week ago. A year ago the 30-year averaged 6.14 percent. It took a national average 0.7 point to obtain that rate, though; a point is 1 percent of the loan amount, paid upfront as prepaid interest.

Rates on other types of mortgages also dropped this week, although not as much as the 30-year mortgage.

The 15-year fixed-rate mortgage averaged 4.92 percent with an average 0.7 point, down from last week when it averaged 5.20 percent. A year ago the 15-year loan averaged 5.79 percent. The 15-year mortgage has not been lower since April 1, 2004, when it averaged 4.84 percent.

Five-year Treasury-indexed hybrid adjustable-rate mortgages averaged 5.60 percent, with an average 0.6 point, down from last week when it averaged 5.82 percent. A year ago, the 5-year ARM averaged 5.90 percent.

One-year Treasury-indexed ARMs averaged 4.94 percent this week with an average 0.5 point, down from last week when it averaged 5.09 percent. At this time last year, the 1-year ARM averaged 5.51 percent.

New chapter for ultra low Fed funds rate

The Federal Reserve Tuesday, Dec. 16 switched to a range for its key target rate from 1 percent to a historically low range of zero to 0.25 percent, effectively cutting its key rate for overnight lending to banks by between 0.75 percent and 1 percent. The Fed also cut the interest it pays on reserves to 0.25 percent in an effort targeted at the traded fed funds market, where rates have been hovering close to zero.

Prior the announcement, the actual funds rate, which is charged on excess reserves banks lend to each other overnight, had already fallen to below 0.2%, well below target, in part because the banking system is awash with unneeded reserves. Therefore the FOMC is now aiming at a range rather than a level because of the difficulty of hitting the latter.

The Fed committed to keeping the target rate there for some time. It also said it will seek to support financial markets and the economy by measures that sustain the size of its balance sheet at a high level, listing a range of programs, from purchases of agency debt to mortgage-backed bonds to the possible purchases of Treasuries.

The central bank's policy panel, Federal Open Market Committee decision (FOMC), signals the end of interest rate cuts as a way to promote economic growth and points to the start of a new period in which expansion of the money supply has become the Fed’s primary tool. Having used up its conventional monetary firepower, it promised an unconventional strategy, such as the buying of mortgage-related securities and, possibly, Treasuries to lower long-term borrowing costs. Unconventional monetary policy is often called “quantitative easing” because its effect is felt through the quantity rather than the cost of credit. Through an array of lending programmes, the Fed’s balance-sheet has soared from below $900 billion to more than $2 trillion, and is about to grow further.

The Fed move is unlikely to have a huge impact for the repo market, a key secured lending market for banks and other financial institutions, as rates there have already plunged to low levels.

The Fed’s move should bring further relief to unsecured interbank lending markets. The London interbank offered rate has been falling since mid-October amid aggressive Fed efforts to provide liquidity to the financial system, and the key three-month Libor will likely plunge further. That’s good news for corporations and consumers, as Libor is the benchmark for adjustable-rate borrowing, including ARMs.

For money market funds, particularly those that invest mostly in Treasurys, the low level of fed funds and the Fed’s commitment to keep rates low for an extended period could create problems. Net yields, the returns these funds make on investments minus their expense ratios, could fall to zero or turn negative, forcing the funds to either waive fees or cut expenses to retain investors. Recently yields on Treasurys have fallen to historic lows. Just last week, three-month bill yields turned negative and an auction of four-week bills yielded zero.

The dollar fell sharply, particularly against the euro, after the Fed’s action. That may weaken the European Central Bank’s reservations about cutting rates again. Similarly, if the weaker dollar takes pressure off sterling, the Bank of England may be more willing to ease again.

Oil prices dips below $40

Oil prices tumbled below $40 a barrel for the first time since the summer of 2004 Wednesday as market ignores an announcement from OPEC of a record production cut of 2.2 million barrels a day.

Light, sweet crude for January delivery tumbled 8 percent, or $3.54, to settle at $40.06 on the New York Mercantile Exchange. Earlier, the contract fell to an intraday low of $39.88 a barrel in electronic trading on Globex. The last time oil prices dipped below $40 a barrel was July 21, 2004 before settling that day at $40.09.

The drop shows that even the mighty Organization of Petroleum Exporting Countries has little sway over a growing global recession, analysts said. Crude prices are down more than 72 percent from their summer peak of $147 a barrel and more than 52% over the past three months, yet tankers continue to idle in the Gulf of Mexico and other ports waiting for buyers.

OPEC had already announced cuts totaling 2 million barrels earlier this year, also with little effect. The unprecedented production cuts and the market reaction show just how fast energy demand has fallen during the worst economic downturn in at least a generation. Many countries around the world have slipped into recession, leading to a sharp decline in demand for oil.

Retail gas prices, which hit a low of $1.656 a gallon on Friday, rose to $1.667 a gallon Wednesday, according to auto club AAA, the Oil Price Information Service and Wright Express.

Good side of recession

The U.S. economy has been officially in a recession since December 2007 as significant decline in economic activity, triggered by the housing downturn starting in 2006, spread across the economy, lasting more than a few months. The economy contracted at a seasonally adjusted 0.5 percent annual rate in the third quarter of 2008.

For sure the recession is bad as it drives up unemployment. It has the good side though. Here are some benefits of the recession:

• Unsupportable debts are being erased.
• Inefficient businesses are wiped out.
• Dying industries are being cleaned up.
• Workers are exiting dying industries.
• Consumers are rebuilding their savings
• Consumers are lowering their living standards to match reality.
• Asset prices, especially houses and stocks prices, are falling to or below their fair value
• Assets taken away from weak hands and given to strong ones (through distress sales, foreclosures, and bankruptcies) create the conditions for future growth.

Banking system is flooded with money

Since mid-September the Federal Reserve has been moving toward a new policy called quantitative easing, or commonly called "printing money”, which essentially pumps enormous amounts of funds to the banking system beyond what the system need. The policy is intended to stabilize the markets, maintain the Fed's interest rate target, and affect the rates on other types of credit. The ultimate goal is to support financial markets and revive the economy.

As a result, the excess reserves in banking system exploded to unprecedented amount. The challenge is that the banking system is still reluctant to lend under the current condition. While the policy didn’t work well in Japan from 2001 – 06, it comes with risk of sparking inflation.

Here is what BusinessWeek said about the policy.

… Until the Sept. 15 bankruptcy of Lehman Brothers, excess reserves, or those funds available for trading between banks in the overnight markets, had typically averaged about $2 billion a week. Since then they have exploded to an unprecedented $605 billion a week on Nov. 19. As a result, interbank funds are already trading well below the Fed's 1% target rate. That means actual policy is even looser than the target rate indicates…

… The Fed's Nov. 25 decision to begin buying up to $600 billion in mortgage debt and mortgage-backed securities from Fannie Mae (FNM), Freddie Mac (FRE), and the Federal Home Loan Banks is the biggest step yet in this new strategy…

… This program, plus the Fed's plan to lend up to $200 billion to holders of securities backed by credit-card debt, auto loans, and small business loans should breathe some life into the moribund securitization process that is so crucial to the flow of credit.

… Japan's experience showed the strategy did little to boost lending. Right now in the U.S. there is little desire to lend or borrow. There's also the long-term risk that flooding the system with money will spark inflation.

A Blue Christmas: Another 533,000 jobs vanished in November

U.S. payroll fell by 533,000 in November, the Labor Department reported on Dec. 5. That monthly job loss is the worst in 34 years, since December 1974. A total of 1.9 million jobs have been lost, since the recession began 11 months ago.

The unemployment rate crept up to 6.7%, the highest jobless rate in the past 15 year, since October 1993. A broader government measure of joblessness, which includes people who want a job but have given up looking for work, rose to 12.5%.

House prices are tumbling almost everywhere

Residential-property prices are tumbling in 23 of the 45 countries on a quarter-on-quarter basis, surveyed by an estate agent, Knight Frank.

The Economist’s house-price indicators continue to show that house value has fallen sharply. America’s housing market suffered the most among the 20 countries covered.

Chart: Courtesy of The Economist

Official call of U.S. recession

The U.S. economy has been in a recession since December 2007, a committee of economists at the research organization National Bureau of Economic Research (NBER) said Monday. The economy reached a peak in December and has been declining since, according to the Business Cycle Dating Committee of the NBER. The U.S. economy had expanded since November 2001, which is the end of the last recession.

This is an official announcement of what most people have already believed about the downturn of the U.S. economy.

"A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income and other indicators," according to the NBER's statement. It typically takes a long time after the start of a recession to declare its start because of the need to look at final readings of various economic measures.

The committee does not judge a recession as two consecutive quarterly declines in gross domestic product as many people believe. That has yet to take place during this recession.

Instead, the NBER follows five key indicators to define a recession, of which the two most important are GDP and employment.

The NBER said that the deterioration in the labor market throughout 2008 was one key reason why it decided to state that the recession began last year.

The economy shrank in the final quarter of 2007 at a 0.2 percent annual rate before barely edging up at the start of this year. The U.S. economy contracted at a seasonally adjusted 0.5 percent annual rate in the third quarter of 2008.

Chart: Courtesy of the Wall Street Journal

The broader economic malaise was triggered by the housing downturn, which started in 2006. The fall of housing prices from peak levels reached earlier this decade cut deeply into home building and home purchases. This also caused a sharp rise in mortgage foreclosures, which in turn resulted in losses of hundreds of billions of dollars among the nation's leading banks and a tightening of credit.

The last two recessions (1990-1991 and 2001) lasted eight months each, and only two of the 10 previous post-Depression downturns lasted as long as a full year, according to the NBER.

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