I never thought I would find myself saying this but I actually think that Americans and congress have just demonstrated their intelligence in their reaction to the proposed $700 billion mortgage bailout plan. Maybe it’s just another example of “The Wisdom of Crowds” - the fact that a group of people can arrive at better decisions than a simple average of individual decisions - but I’m impressed with the results of a process that I usually despise. Not that I agree with everything that is being layered onto the plan, but for the most part I think it will actually end up being a better plan after all the obvious posturing is finished.

For starters, like most people, I am outraged that the government has to step in and clean up a mess in the private sector. I love the fact that Lehman died an unnatural death and would love to see even more of the culprits bite the dust. However, I believe Paulson and Bernanke when they tell us that without some intervention we will experience a catastrophe of biblical proportions:

Real wrath of God type stuff.
Fire and brimstone coming down from the skies! Rivers and seas boiling!
Forty years of darkness! Earthquakes, volcanoes…
The dead rising from the grave!
Human sacrifice, dogs and cats living together… mass hysteria!

But do we give them a blank check? Well, the American people and congress have spoken and the answer is No! Here are some of the modifications being sought:

Execute this program on the installment plan, with additional draw downs needing approval. I like this idea, but maybe for different reasons than intended.  No one can know what the real need is but if they give Treasury $700 B then $700 B will be spent. One of my concerns is that the government isn’t merely trying to avoid a depression but they are also trying to avoid a recession. But a recession might actually be healthy for the economy in the long run. So if they have to go back for approval periodically that could discourage them from going overboard.

Take equity stakes in the companies being helped. Seems like a good idea to me. Look at Warren Buffet. He just negotiated a sweet deal with Goldman because he’s the  800 pound gorrilla. Well the US government is the 2000 pound gorilla and should be able to get an even sweeter deal. Besides, this bailout needs to be painful for those who screwed up.

Cap executive compensation within rescued companies. Now normally I would abhor the government influencing executive compensation, regardless of how outrageous it is. But this time it’s different. These companies are taking government money so it can’t be siphoned off into executives’ pockets. Besides, under my pain theory these CEOs need to suffer from their mistakes. There will probably even be a side benefit to a compensation cap. It will prevent CEOs from taking advantage of the taxpayer dollars if they don’t really need the help.

And I’m not the least bit worried about there being a talent shortage because I think these executive types are over-rated anyway. There are a lot of smart people out there waiting in the wings to jump in and take over for $400,000 per year. I don’t subscribe to the view that you have to have a celebrity CEO. In fact, I suspect that the celebrity types are not as smart as the underpaid quiet types. They got us into this mess.

Provide oversight. I have no idea how this would work but in principle it sounds like a good idea.

Helping distressed homeowners. This is the one that concerns me the most. As if this proposal doesn’t already help homeowners by propping up home prices? I’m OK with modifying the bankruptcy laws slightly but what more do they want?

Aside from this last add-on, by and large, the political process seems to be working. The key question that is still up in the air is how to set the purchase price for these assets. That issue alone could make or break this deal for the American taxpayer.

…Happy Days Are Here Again.

Well, that might be a bit of an overstatement but not by much. In reaction to the Fannie and Freddie takeovers bank stocks were up today and so were homebuilders. In fact, Toll Brothers (luxury homebuilder) was up 9.4%, reaching its highest level in more than a year. The reason for all the optimism is that some folks are predicting that mortgage rates will drop by a full percentage point in the next week or so as the governement’s actions reduce the risk of funding mortgages. So this would appear to be good news for the housing market.

Could this be the bottom of the housing market? Not so fast!

The fundamental problem is that all this appears to be the very visible hand of the government interfering with the markets and artificially supporting housing prices. It might work for a while but in the end houses must be priced in accordance with fundamental values. And if prices are being propped up for now then it just means that the day of reckoning has been postponed. Either they will ultimately come down or they will stop moving up until fundamental value catches up with prices.

Despite, and in some cases because of, all the turmoil in the mortgage markets there are still creative ways to finance a real estate purchase in the Chicago market if you know where to turn. We work with a few different lending professionals that keep us in the loop on the current alternatives available.

For instance, Tom Fishwick of Guaranteed Rate tells me that he still has the ability to do 97% financing with borrower paid mortgage insurance. However, only one lender out of the 40 he works with and one mortgage insurer out of 5 will currently back such a loan and I imagine it’s only available for people with very good credit scores. Of course, his fear and mine is that this type of loan will disappear any day as the mortgage situation continues to deteriorate.

Tom also shared with me some updated pricing of FHA loans where borrowers can get up to 97% financing if their credit score is above 499 (you can also get loans with scores below 499, but you need a bigger down payment). However, there is a mortgage insurance premium that depends upon the loan to value ratio and the borrower’s credit score. There is an up front premium that ranges from 1.25% to 2.25% of the loan amount and an ongoing premium that ranges from 0.50 - 0.55% of the loan amount on an annual basis. The other trick is that the home must be FHA approved, which is usually not a problem unless it is a condominium. Then you get into a whole range of additional issues that I just don’t want to get into here.

This week I also heard Barbara Fifield of Chicago Bancorp who told me about a new program they are offering for people at the other end of the financial spectrum. This program allows buyers to borrow up to 80% of the value of stocks deposited with the lender with no income or credit score. However, this means that the stocks that are deposited can no longer be traded, though you still collect the dividends from them. In addition, as you can imagine, if the price of the stock goes down by more than 20% you have to come up with additional collateral - or they can sell off your stock and pay down the loan.

Regardless of how bad the mortgage situation gets people will always come up with creative ways of keeping the business running.

Well, I guess that’s the problem. They’re up.

The decline in mortgage rates seems to have not only stopped in the last several weeks but it has actually reversed. During the last 12 months we have seen the rate on 30 year fixed mortgages peak at 6.4% in the middle of last year and then decline to a low of 5.3% in January. However, since then they have bounced back up to 6.1% where they are currently.

If you’ve been listening to the news this may surprise you a bit as you have been hearing a lot about what the Federal Reserve has been doing to help out the credit markets, including lowering interest rates. So you’re probably wondering what is really going on.

The answer is, as usual, that nothing is ever as simple as it seems. First of all when they say that the Federal Reserve is lowering interest rates what they are talking about is the rate on what is called federal funds, which is the rate charged for overnight loans of bank reserves at the Federal Reserve. It’s basically a short term interest rate. However, mortgages are longer term loans and unfortunately as short term rates have moved down investors have become concerned about inflation. Inflation is a byproduct of the abnormally low short term interest rates that the Fed has been creating and when investors become concerned about inflation they want a higher interest rate if their money is going to be tied up for any length of time. So this is one reason that mortgage rates have risen.

But there are other reasons as well. I’m sure you’ve heard about the rising defaults on mortgages. As investors start to get burned by defaults they start to demand a higher interest rate to compensate for those defaults. In addition, with all the turmoil in the financial markets lately large investors have been forced to liquidate some of their portfolios. Consequently they have been forced to sell large quantities of mortgages into the market. With a shortage of buyers in the market, those investors that are buying start to demand a higher rate of return and that also drives up mortgage rates.

So what does all this mean for the average homebuyer and seller? Well, I’m afraid it’s not good news. You can use our loan calculator to experiment with the numbers yourself but according to my calculations an interest rate increase from 5.3% to 6.1% on a 30 year loan results in a 9.1% increase in one’s monthly payment. So either buyers have to buy 9.1% less home or sellers have to cut their prices 9.1%. So, in a way it pays to stay on top of mortgage rates and to be ready to move quickly when rates are attractive. But don’t get carried away. The fact of the matter is that no one can predict which way rates are headed and there is no way to pick the absolute bottom. Besides, there is no guarantee that you will find that perfect home just when mortgage rates bottom out.

For those who are interested, we have created a page on our site to help you stay apprised of the recent mortgage trends.