The economic fundamentals that have come out in the last week or two have all been, shall we say, poor.   Not just in the United States, but England, Asia and other places, the economic reports all show pretty solid evidence that we are either in or heading into (depending on where you are) a recession and that it’s most likely not going to be a short recession but more likely the opposite – a long and painful one.   I’m not going to go into the details of the different reports because it would be too depressing.

Earnings Reports (or shall we say, loss reports?)   I’m going to do something a little different this time.   I’m going to give you the numbers and then later in the e-mail, I’ll tell you who they matched with.   Here’s the numbers:

(oh and these are all just for the most recent 90 days).

Here’s the choices for the companies who made them:

Now for a few thoughts about what’s going on in the equity markets and how that has an impact on the mortgage and real estate markets.   Here’s an overview of it:

1. The mortgage backed securities market is a highly leveraged market.

2. As approximately 5 to 7% (that’s right, it’s only 5 to 7% of all mortgages that are causing this problem) go bad, the value of the mortgage backed securities (also known as Collateralized Debt Obligations or CDO’s) fall dramatically.   Since they are highly leveraged, the investors have to come up with additional cash, typically lots of it.

3. That is, in an oversimplified nutshell, what is causing the significant sell offs in the stock market and the bond market at the same time.  Investors, typically hedge funds, are needing to raise cash and to do that they are selling everything.

Now keep in mind how bonds and mortgage rates work.   They actually move in reverse from each other.   When bond prices go down, bond rates go up and vice versa.

So, when everyone is selling bonds, that sends bond rates (and correspondingly mortgage rates up).   Which creates the reverse spiral that we don’t need.

I’m convinced that if the overleveraged problems that are in the economy and the markets right now were to “disappear” we’d see long term rates drop quite substantially.   That would then encourage more people to step out and buy a new house.   That would in turn improve the housing market which would increase the value of the mortgage backed securities (because less people would be “under water” on their houses).   That would then reduce the need for people to meet margin calls and sell their investments.

See what an incredibly tangled web we have weaved?  (Is that the correct grammar?)   I’m not too much of a betting man, but if I were, I’d bet you that Treasury Secretary Paulson and Fed Chairman Bernanke and their staffs are currently working on trying to break that cycle.   I wish them luck because I don’t know how to break it.

Now, did you guess who had which earnings (losses?)

Well, here we are on Friday again.   Are you getting motion sickness from all of the news and rumors that are flying back and forth?   Wow has it been another week to forget, hasn’t it?

Here are the topics we’re going to talk about today:   The Bailout/Rescue Plan, some very weak economic reports, the credit markets and do bankers really trust each other?

First, there were several economic reports that came out.  None of them were good.   Here’s a rundown of them:

1. Jobs – the jobs report came out this morning and showed that 159,000 jobs were lost in September.   While the number was lower than what the markets expected (they expected 200,000), it was a very weak report.

2. Factory orders came in down 4%.   That’s not the direction we’d like them to go.

3. Car Sales fell off a cliff in September.   Ford’s sales dropped 35%.   Ouch.

4. A couple of reports on personal incomes, personal expenditures and the like came out and they weren’t good.

If these were the only issues that we had, we’d have our hands full and we’d see mortgage rates drop due to the increased weakness in the economy.

But that’s not all.  The credit markets have taken a major hit in the last week.   What’s happening with that?   A couple of brief highlights:

1. Banks are very concerned about running out of money (capital).   Wachovia (more on this later) and Washington Mutual have been “bought out” to keep them from going under.   Other banks are concerned that the losses they are experiencing will not enable them to keep their capital ratios where they should be.   Due to that, there is an increasing reluctance to lend to commercial customers and to lend to consumers.   How bad is it?  I’ve heard a variety of conflicting reports.   What I can say from personal experience is that for people (consumers, not businesses) who have the following:  1) Some equity in the item they want to borrow against (car, house, boat) 2) Good credit – not spectacular credit, but at least good credit, 3) sufficient verifiable income to support the loan request and 4) Cash reserves – i.e. you’re not flat out broke after closing shouldn’t have problems getting the financing.

2. As the economy continues to falter, the concern, in banks writing loans to commercial customers, is what is the likelihood of the commercial loans and lines of credit getting repaid.   That makes borrowing more expensive (when they can get it) and difficult to get.   For those who run businesses that need financing (to maintain inventory, etc.) it makes being productive and keeping their portion of the economy going.

Banks don’t really trust each other.   Surprise?

Well, sort of.   Here’s the scoop.    Many banks actually lend money back and forth to each other.   They do it literally on a daily basis (i.e. Wells could say to JP Morgan – can you loan me $100 Million until Monday?).    With the issues that are going on in the financial firms, very few banks are inclined to lend to other banks.    Why?   Because they don’t want to loan money to a bank who is going to go under next week.    How’d you like to loan someone $100 Million and find out that the FDIC is shutting them down.   So there is now very little lending done between banks and the rates that they would charge is skyrocketing.    In addition to that, the financial stress that this is causing is extending to banks in other countries and causing growing concern that other banks in other countries are going to fail.

Oh, and also, Citigroup and Wells Fargo really don’t trust each other.   Citigroup thought they had bought Wachovia but this morning Wells came in and made a better offer.   So now they are fighting over it.   Me first!  No, it’s mine!

The Bailout Bill – as of about 10 minutes before I finish writing this, the Bailout Bill passed by the House of Representatives.   So now what?   A few thoughts on the bailout bill:

1. We needed to do something.   You can’t fiddle while Rome burns, the stakes are indeed too high.

2. There are a lot of people who feel that this bailout bill, while flawed, was better than nothing.

3. There’s also a growing feeling that the economic issues (see above) are going to be more than just what this bill can deal with.

So where does this leave the mortgage market?

1. The fact that it passed will keep the conforming market moving.   Fannie and Freddie and FHA loans will still get done.

2. The economic weaknesses that are present should push mortgage rates down.   They haven’t dropped this week (like they usually would with economic reports like we had) because of the uncertainty of what was going to happen in Washington.

3. Since the consensus in the markets are that this plan that just passed won’t solve the economic problems and won’t cure the housing market, we’re going to see continued tightening of lending requirements and over the longer term, I expect we’ll see mortgage rates trending up.

That’s about all that I’ve got for now.   Stay tuned because it’s not over yet.

Tom Vanderwell