Morning Report: Discussing the mortgage interest deduction

Vital Statistics:

	Last	Change
S&P Futures	2582.0	-1.0
Eurostoxx Index	396.3	0.3
Oil (WTI)	56.0	0.3
US dollar index	87.9	0.0
10 Year Govt Bond Yield	2.32%
Current Coupon Fannie Mae TBA	102.875
Current Coupon Ginnie Mae TBA	103.938
30 Year Fixed Rate Mortgage	3.95

Stocks are flattish this morning on no real news. Bonds and MBS are up. 

It should be a quiet week with respect to market-moving data and Fed Speak. New York Fed Governor William Dudley speaks at noon today, and that is it for the week. William Dudley is set to retire in mid-2018.

Work on tax reform continues, with both the House and the Senate drafting their own bills. Blue state Republicans (especially in CA, NY and NJ) are fighting to save the state and local tax deductions. The House hopes to vote on the bill next week. My sense is that the path to passage is so narrow that it will be a largely symbolic bill designed more to achieve a legislative victory than to reform taxes. I also think the estate tax will survive in order to save the state and local tax deduction. 

White House economic advisor Gary Cohn says that he doesn't think eliminating the mortgage interest deduction will affect the housing market. “The ability to deduct interest is a component that allows you to buy a bigger house, not what drives you to buy a house,” Cohn said during a Bloomberg Television interview Friday. It will affect the luxury market (especially in areas like the Northeast, where the luxury market is already weak),  but with the median house price around $245,000 limiting the mortgage interest deduction to $500,000 won't affect most MSAs. If you wanted to eliminate the MID at a point where it will cause the least amount of pain, now would be the time to do it, simply because low interest rates are making the interest portion of the typical mortgage payment small by historical standards. Back when interest rates were super high in the early 80s, almost 100% of your first year's mortgage payment went to interest. Today, about 70% is interest. 

The National Association of Realtors weighed in on the mortgage interest deduction as well, and they are against changes to it, as you would expect. They commissioned a study earlier this year that predicted a 10% drop in home prices and that homeowners with incomes between $50,000 and $200,000 would see an average increase in taxes of $815. 

One wrinkle to the change in the MID is that it applies to newly-purchased homes. So, if you haven't moved, your existing MID would not change. That will make depress existing home sales at the margin, but I can't see people staying put simply because of tax treatment of mortgage interest. People move for various reasons, but tax treatment usually isn't one of them. Regardless, if this provision stays, the death of the MID will have a much less dramatic effect than people are forecasting. 

Morning Report: Decent jobs report

Vital Statistics:

	Last	Change
S&P Futures	2579.0	2.3
Eurostoxx Index	395.2	0.3
Oil (WTI)	54.8	0.3
US dollar index	87.7	0.0
10 Year Govt Bond Yield	2.34%
Current Coupon Fannie Mae TBA	102.875
Current Coupon Ginnie Mae TBA	103.938
30 Year Fixed Rate Mortgage	3.95

Stocks are up small after the jobs report. Bonds and MBS are up small. 

Jobs report data dump:

• Nonfarm payrolls up 261,000 versus 325,000 expected
• 2 month payroll revision up 90,000
• Unemployment rate 4.1% versus 4.2% expected
• Labor force participation rate 62.7% vs 63% expected
• Average hourly earnings flat / up 2.4% YOY.

Overall, a decent report. Payrolls disappointed, but the 2 month revision more than made up for the miss. The unemployment rate is now the lowest since 2000. The drop in the labor force participation rate and flat hourly earnings were disappointing, however. This report won't make any difference to the Fed's thinking for December, and the market is basically calling a 25 basis point hike a sure thing at this point. 

Note that the miss in average hourly earnings was driven in part by the hurricanes. Restaurant and bar jobs were hit the hardest in the areas affected, and they are lower paying jobs. The loss of these low-paying restaurant and bar jobs in September artificially increased average wages overall. That effect was reversed in October. 

The PMI for services was flat in October, while the ISM Services index increased to 60.1. Hurricane effects could be coming into play here as well. 

Factory orders increased 1.2% in September, as the manufacturing sector continues to expand. 

If you heard a snap yesterday, that was the sound of McMansions in places like Darien, CT and McLean, VA cracking on the proposed sharp reduction in the mortgage interest deduction. Luxury homebuilder Toll Brothers was down 6% yesterday on the proposal, which lowers the MID cap to $500,000 and ends the deduction for second homes. The homebuilder ETF was only down 2.5%. Automaker Tesla was also hit 7% on the proposed elimination of the $7,500 electric car tax credit. I also wonder how this will affect jumbo delinquencies and demand for jumbo MBS.  

The NAHB is warning that the change in the mortgage interest deduction could trigger a housing recession. Their point is that it will cause weakness in some high end markets and that weakness will spread to others. FWIW, I think the sheer lack of inventory is the most important characteristic of the current housing market and that will dominate. That said, it won't be good for home prices in the million dollar range at the margin, and some markets in California could see a moderation of home prices. 

Morning Report: Existing Home Sales fall

Vital Statistics:

	Last	Change
S&P Futures	2447.0	5.5
Eurostoxx Index	375.8	1.8
Oil (WTI)	47.7	0.3
US dollar index	86.1	0.1
10 Year Govt Bond Yield	2.19%
Current Coupon Fannie Mae TBA	103.09
Current Coupon Ginnie Mae TBA	103.97
30 Year Fixed Rate Mortgage	3.89

Stocks are higher this morning on no real news. Bonds and MBS are flat.

Today starts the Fed conference in Jackson Hole. No major speeches are planned for today, however Janet Yellen speaks tomorrow. There is the possibility of some volatility around then. The big question will be whether Yellen is nominated for another term or will she be replaced when her term expires next year. National Economic Council Chairman Gary Cohn is the name most mentioned as a replacement. Donald Trump criticized the Fed's low interest rate policy while on the campaign trail, but it will be interesting to see if he nominates a hawk. Most politicians prefer doves when push comes to shove. 

Initial Jobless Claims fell to 234k last week. The labor market remains strong as companies hang on to their workers. 

Existing home sales fell 1.3% in July, according to NAR. This is up 2.1% YOY, but is the lowest number of 2017. Lawrence Yun, NAR chief economist, says the second half of the year got off on a somewhat sour note as existing sales in July inched backward. “Buyer interest in most of the country has held up strongly this summer and homes are selling fast, but the negative effect of not enough inventory to choose from and its pressure on overall affordability put the brakes on what should’ve been a higher sales pace,” he said. “Contract activity has mostly trended downward since February and ultimately put a large dent on closings last month.” The median house price was $258,300 which is up 6.2% YOY. Unsold inventory is down to 4.2 month's worth, from 4.8 months a year ago. 

What are the most active real estate markets right now? Colorado Springs, Chicago, and Reno. Least active? San Francisco, where the average house price is now over a million. Much of the Northeast is cold as well. What makes a market active? Access to both good jobs and affordable homes. 

Big money managers are swapping corporate debt for mortgage backed securities, particularly subprime MBS from before the crisis. Corporate debt simply got too expensive, and MBS got too cheap. The supply of subprime MBS has been shrinking however as loans get paid off, and non-agency MBS outstanding are about 25% of what they used to be. For fixed income managers, MBS have outperformed most everything this year. The appetite for MBS paper is encouraging, as it would open up the origination business to more outside-the-box product and allow credit to be extended to borrowers who have been more or less shut out of the market post-crisis. 

A reduction in the mortgage interest deduction is on the table as part of tax reform. The talk is that the cap would drop from $1 million to $600k or so. Toll Brothers CEO Doug Yearley said reducing the MID would be bad policy and would discourage homeownership. Of course Toll is in the McMansion business, so he is talking his book a little. Bob Shiller thinks the effect would be de minimus as it would only affect something like 4% of taxpayers. 

Morning Report: RIP the mortgage interest deduction?

Vital Statistics:

	Last	Change
S&P Futures	2158.0	12.0
Eurostoxx Index	341.2	1.6
Oil (WTI)	50.6	0.8
US dollar index	87.6	-0.2
10 Year Govt Bond Yield	1.72%
Current Coupon Fannie Mae TBA	103.3
Current Coupon Ginnie Mae TBA	104.2
30 Year Fixed Rate Mortgage	3.54

Bonds are closed today, but overseas bond markets are weaker. Stocks are up.

No economic data today. The week after the jobs report is typically data light to begin with, and there really isn't anything market-moving this week, except for may the PPI on Friday. 

Dave Stevens of the MBA raised the issue of eliminating the mortgage interest deduction, albeit with the caveat that it be done in the context of tax reform, with lowering rates and eliminating deductions. He wasn't advocating eliminating it in a vacuum. 

If Donald Trump wins, tax reform is a definite possibility. If Hillary wins, will she be more like her husband, willing to deal with Republicans to get something done, or will she be more like Obama, where both sides had hardened positions? If you were going to eliminate the mortgage interest deduction, it will certainly make housing less affordable and would have a dampening effect on home price appreciation. That said, with rates as low as they are, interest payments as a percentage of your mortgage payment are at all-time lows. So if you wanted to eliminate it at the time when it causes the least amount of pain, now is the time to do it. 

Republicans will never support eliminating deductions without cutting rates, and the historical bargain between right and left (Democrats trading increased taxes and spending for increased defense spending) might not work this time around. Believing in that trade was what got us the sequester, where Obama found his bluff called, as Republicans tolerated lower defense spending in exchange for lower discretionary spending. Given the general war fatigue of the American voter, Republicans are probably not going to be willing to trade increases in defense spending for more social spending, and certainly not for tax increases. 

Punch line: the mortgage interest deduction probably isn't going anywhere.

That said, the US subsidizes the residential real estate market six ways to Sunday, with the mortgage interest deduction, the 30 year fixed rate mortgage (try finding that anywhere else on the planet), taxpayer backing of almost all new origination, and the cornucopia of subsidies for affordable housing. Not to mention the central bank targeting of mortgage rates and real estate prices. And the powers that be still scratch their heads wondering why we had a real estate bubble...

Mortgage credit availability improved in September, according to the MBA. 

Morning Report: Fed week

Vital Statistics:

	Last	Change	Percent
S&P Futures	1950.2	0.6	0.04%
Eurostoxx Index	3182.0	-6.0	-0.19%
Oil (WTI)	44.4	-0.2	-0.52%
LIBOR	0.337	0.001	0.36%
US Dollar Index (DXY)	95.36	0.162	0.17%
10 Year Govt Bond Yield	2.17%	-0.02%
Current Coupon Ginnie Mae TBA	104.2	-0.1
Current Coupon Fannie Mae TBA	103.7	0.1
BankRate 30 Year Fixed Rate Mortgage	3.84

Markets are flattish this morning as overseas markets stabilize. Bonds and MBS are up.

No economic data today. We will have some important economic data this week retail sales and industrial production on Tuesday, with housing starts on Wednesday.

The big event this week will be the FOMC meeting on Wednesday and Thursday. The announcement will come on Thursday. For mortgage bankers, the focus will be in the Fed Funds rate, and also "reinvestment tapering." Reinvestment tapering has to do with the Fed's re-investment of maturing Treasuries and MBS that it bought during QE. Currently, the proceeds from any maturing MBS are re-invested back into the MBS market, in order to keep the Fed's balance sheet constant. At some point, they will stop doing that, and you may see mortgage spreads widen. This means that mortgage rates could increase, even if the 10 year goes nowhere. Note that they probably will taper, meaning they won't stop re-investing maturing proceeds all at once. They'll probably cut it by $5 billion a month, similar to how they executed the tapering in the first place. 

The Fed Funds futures are currently projecting about a 30% chance the Fed will tighten this week. Fed Vice Chairman Stanley Fischer is advocating moving before the inflation numbers begin to rise. “There is always uncertainty and we just have to recognize it,” he told CNBC television on Aug. 28. Asked if the Fed should delay an increase until it had an “unimpeachable case” that a move was warranted, Fischer replied, “If you wait that long, you will be waiting too long.” On the other side of the coin, many in the Fed are worried about repeating the mistake of 1937, where the Fed tightened (really only by a little bit) and the economy dove back into recession. 

Exhibit (A) in the "ZIRP is not free" argument: Petrobras sold 100 year (!) bonds last June, and as oil has dropped so have these bonds. They dropped into the 60s recently. What does this have to do with ZIRP? Everything. When central banks hold down rates artificially, the price signals the market uses to assign risk (interest rates) become distorted and investors are forced to reach for yield. You see it mainly with pension funds and insurance companies, which have to hit a return bogey based on longevity and health care inflation. Yes, getting 6.85% in this interest rate environment is attractive, but, you are lending to a Brazilian oil producer for 100 years and only getting 6.85% a year! The last 3 times the Fed raised rates (94,99, and 05) they blew up the MBS market, the stock market bubble and the residential real estate bubble. This bond issue shows how much of a credit bubble we currently have. The Fed may have painted themselves into a corner, but until inflation comes back, they can wait. 

Presidential candidates are beginning to put out their tax and spending plans. Jeb Bush recently put out his tax plan, and there are some items that will directly affect those in the real estate business. First, his plan reduces rates and limits deductions. State and local taxes will no longer be deductible. Second, there will be a cap on itemized deductions, which means people who have a large mortgage and pay a lot of mortgage interest will find themselves with a higher tax bill. This will probably have a negative effect on the jumbo side of the market, although it will present an opportunity for LOs to try and pitch refinancing from 30 year mortgages to 15 year mortgages. While the mortgage interest deduction is as American as apple pie and may in fact be a political third rail, economists believe that it hasn't really increased the homeownership percentage, as it was intended to do - it just encouraged people to buy bigger houses. 

Morning Report - Ed DeMarco and G-fees

Vital Statistics:

	Last	Change	Percent
S&P Futures	1413.3	6.2	0.44%
Eurostoxx Index	2571.5	24.7	0.97%
Oil (WTI)	88	1.5	1.75%
LIBOR	0.311	0.000	0.00%
US Dollar Index (DXY)	80.14	-0.196	-0.24%
10 Year Govt Bond Yield	1.63%	0.00%
RPX Composite Real Estate Index	191.2	-0.2

Markets are stronger this morning on optimism over a deal on the fiscal cliff.  3Q GDP came in at 2.7% lower than the 2.8% estimate, but higher than the initial 2% estimate. Initial Jobless Claims were 393k and the prior week was revised upward.  Bonds are down, while MBS are flat.

The mortgage interest deduction, once considered untouchable, could be part of a deal on the fiscal cliff. Certainly that would be a negative for house prices, especially in expensive areas like DC, NYC metro area, and the West Coast.

Another tax break is the Mortgage Forgiveness Debt Relief Act, which is scheduled to sunset at the end of the year.  This prevents borrowers from getting a tax bill if they do a short sale or get a principal forgiveness mod on their loans. Consumer advocates are urging Congress to extend the tax break.

SAC has received a Well's notice. Stevie Cohen has apparently not been named in the Martoma case or the SEC's documents, but the noose is tightening.

FHFA Acting Director Ed Demarco gave a speech at the Exchequer Club in DC yesterday.  Key takeaways:  G-fees have risen and will continue to rise until credit risk is priced as it would be if private entities were doing it. I have seen some estimates that it will go to 75 bps. In addition, they are considering G-fee adjustments by locality, which means borrowers in judicial states will pay more. All of this is in an effort to "crowd in" private capital back to the mortgage market. The ultimate effect will be to make conforming mortgages more expensive, which means the push / pull between the Fed and the regulators will continue.

Jim Grant has a great interview on Bloomberg discussing the Fed's war with the market mechanism and the unintended consequences of ZIRP. Once of the biggest is the creeping "Japanesization" as artificially low rates keep zombie companies alive.

The dog that didn't bark:  The wave of foreclosures that never occurred.

Morning Report - Case Schiller

Vital Statistics:

	Last	Change	Percent
S&P Futures	1403.2	-0.1	-0.01%
Eurostoxx Index	2549.8	7.3	0.29%
Oil (WTI)	87.92	0.2	0.21%
LIBOR	0.312	0.000	0.00%
US Dollar Index (DXY)	80.28	0.033	0.04%
10 Year Govt Bond Yield	1.67%	0.01%
RPX Composite Real Estate Index	190.8	-0.3

Markets are flat this morning after a better than expected durable goods report. The Commerce Department said no companies reported disruption from Hurricane Sandy, although I wonder how much of the orders were caused by Sandy (generators, for example).  Bonds and MBS are flat

The Case-Schiller index rose 3.6% YOY, and is now sitting where prices were in Autumn of 2003. We will get the FHFA Home Price Index later today.

Mary Schapiro has stepped down from the head of the SEC. Elise Walter, one of the Democratic Commissioners has stepped in to take her place.  The criticism of her performance largely centered around the view that she was too lenient with Wall Street. The Walter appointment has the feeling of an interim appointment.  In the meantime, the panel will be evenly split between Democrats and Republicans, which means that enacting controversial new regulations will be almost impossible, especially those regarding prop trading and money-market funds.  That said, my gut tells me that a more aggressive SEC is on the way.  Batten down the hatches.

Brown Forman, the liquor manufacturer, has announced a special dividend, as a way to return capital to shareholders prior to an expected hike in dividend taxes. Expect to see more of this. The stock is up 5%.

CNN discusses the political realities of the mortgage interest deduction.

Fannie Mae discusses the fact that many borrowers don't get competing rates when shopping for a mortgage.