KPIG Radio November 11

Stocks managed modest gains in early trade on little real news. The MBA weekly survey gained 3.3% to 627.5 on an 11.3% jump in refi activity, the 30-year contract rate slipped fractionally to 4.9%. With the fading of the homebuyer tax credit purchase activity is falling rapidly as the purchase index fell 11.7% last week, a 5th consecutive decline. With the Feds purchase of MBS set to end in March 2010 the consensus is that interest rates will jump 1% as a result. Recent Fed announcements suggest that they are willing to continue purchases, compliments of their “will remain flexible” statement. I would expect them to continue purchase’s, as a sharp jump in mortgage and other lending rates even from very low levels will risk substantial economic dislocation, particularly with respect to real estate. It seems more Fed sanctioned, perhaps encouraged is a better word, accounting shenanigans are on tap. Following the issuance of new guidelines to banks holding commercial real estate mortgages. Essentially encouraging them to overlook the decline in commercial real estate asset values, they run 30-50%, if the loan is current. Hence keeping the losses off the banks books and making it appear financially stronger than it actually is. We chided the Japanese for not being aggressive in writing down the value of bad loan collateral held by the banks. This has been fingered to be a substantial contributing factor in their 2 lost decades. Yet here we are encouraging the same thing, extend and pretend. Of the bank failures this year 100 of them had a commercial real estate component. A recent study by Foresight Analytics estimates that 2/3’s of the 800 billion in commercial mortgages held by banks and needing to be refinanced between now and 2014 are underwater. Further a study by Deutsche Bank a short time ago estimated that 2/3’s of the commercial mortgages that need to be refied will find it impossible through a combination of negative equity and CRE credit market dislocation. The latest example of lets close the barn door now that the horse has bolted. While I’m on the extend and pretend subject, its fairly well documented that loan modifications have a very high redefault rate, particularly if the principal is not reduced, of some 50% over the next 12 months or so. The Treasury Department is quick to tout that over 650,000 loan modifications are underway, and this is certainly a very good start to the program. However there is a substantial difference between a trial modification, a permanent modification and a successful modification, meaning one that doesn’t redefault with in a year or so of achieving permanent modification status. Of the 650,000+ trial modifications underway only 1,711 had achieved permanent status as of September 1st. With this program critical to containing the foreclosure tsunami we are facing, the permanent modification success rate needs to jump and dramatically so.