Making Money Alert
The Fed Is In A Box
08/08/2007
Nearly all of Wall Street's eyes were trained on the Federal Reserve yesterday, as the central bank discussed the direction of the economy and interest rates. Of course, we know now that the Fed left interest rates unchanged yesterday, but the Fed did acknowledge the recent volatility in the financial and credit markets.
Last weekend, I saw many of the talking heads on TV discussing how the Fed must step in now and cut interest rates because the stock market was in a free fall. Well, the Fed -- along with everyone else -- breathed a sigh of relief when the Dow rallied 286 points on Monday.
So, does this mean an end to the selling season? Maybe, but I want my Alert readers to understand that the days when the market climbs the highest often occur within the context of a bear market. I think it is simply too early to tell whether the recent correction we've experienced is the start of another dark period in stock prices, but one thing for sure is that the bear market scenario cannot be ruled out -- even if you are a brazen bull.
Remember that this bull market is in its fifth year, so it is an old timer by historical standards. Plus, this long-term market advance has been fueled in large part by the access to cheap money. Now that the mortgage market is in a meltdown (more on this situation in a moment), the playing field has been altered when it comes to credit.
Even if the Fed were to lower interest rates here, I don't think that would change the available access to money for most Americans. An even bigger concern is what would happen to the U.S. dollar if interest rates were reduced. Right now, we are near a 15-year low in the dollar versus rival foreign currencies. In fact, the greenback is down over 33% in just the last five years, and any further interest rate cuts might really do a number on the dollar.
All of this talk about the Fed, interest rates, access to money, the falling dollar, etc., is playing itself out right now in the volatile equity markets.
Looking at the above chart of the S&P 500, we can see that stocks have managed to fight their way back above the 200-day moving average (red line). The S&P 500 is now trading right at its key resistance level of 1490. I think the direction this market takes from here could very well determine whether we see stocks continue to climb or whether we witness another failed attempt to get back to the highs of July.
Whichever way this market wind blows, I want all of my Alert readers to know that we are watching things here with a microscope.
Another area we are watching intently is Treasury yields (see above chart). The 10-year Treasury yield fell all the way down to its 200-day moving average recently, but now it is staging a big move to the upside. The Fed is still worried about inflation, as it told us on Tuesday, and the bond market shares the same concern.
Higher yields mean money is getting more expensive, and once again we have a potential snag to any real equity comeback fueled by access to cheap money.
As this highly volatile environment persists, we think the best place for your serious money is in the relative calm and security of safe harbor investments. Subscribers to my Successful Investing advisory service were able to sidestep the latest market malaise, and watch in peaceful harmony, while this market gyrated recently in an unpredictably wild fashion.
TURMOIL UNDER THE RADAR
I have been on a short vacation this week in Austin, Texas, to visit my brother and his family. Man, what a great town! Like most Americans, I love to travel and see other parts of our beautiful country. Of course, even on vacation my mind is working overtime to keep tabs on all things financial.
An example of this occurred yesterday, when I was enjoying a great big Texas breakfast. At the diner where I was feasting, I grabbed a copy of the Houston Chronicle and saw the headline, "Mortgage Problems Hit Close To Home."
The story talked about a problem that most Americans are completely unaware of, and that is the rising cost of jumbo loans during the past two weeks.
Wells Fargo last week lifted its interest rate on a 30-year fixed rate jumbo loan (any loan above $417,000). These loans are written not on subprime candidates, but on good credit quality customers. These large loans rose from 6.875% to 8%, which is more than a 10% increase in the average monthly loan payment.
Because of this new trend in the mortgage sector toward higher interest rates, I have asked Josh Lewis, our real estate and mortgage expert, to provide us with the full story of what's really happening with mortgage money.
The Mortgage Market Meltdown and You
By Josh Lewis
Anyone who watches the nightly news or reads the newspaper is well aware that the "subprime mess" now has become the "mortgage market meltdown." What most people don't know is what this means, why it happened and how it will impact them. This is a complex issue that will take time to sort out. In this short space, I will try to answer these questions and help you create an action plan to protect you and your family.
What is a "mortgage market meltdown?" What has occurred in the last 10 days is best described as a complete shutdown of the mortgage markets for all loans not guaranteed by the FHA, VA, Fannie Mae or Freddie Mac. Included in this shutdown are all subprime loans, all jumbo loans (loans greater than $417,000) and most "exotic" loans such as Option ARMs and limited documentation loans.
Why did this happen? As recently as the 1980s, getting a mortgage meant going to a bank or savings and loan, which funded your mortgage from their bank deposits. After the savings and loan crisis, the mortgage markets underwent a significant shift due to changes in the regulatory environment. In the new system when you applied for a loan, it often was through a mortgage bank. A mortgage bank is an institution established to originate and sell mortgages. Mortgage banks operate with lines of credit that allow them to borrow money to fund your loan, and then pay off the funds they borrowed by selling your loan into the mortgage market and pocketing the difference as profit.
As you can imagine, Wall Street isn't very interested in buying mortgages that only amount to a few hundred thousand dollars. What they want is to purchase pools of hundreds of similar mortgages that total millions of dollars. Over time, this business became so lucrative that nearly two out of every three mortgages was pooled this way and sold to investors as mortgage-backed securities without the benefit of FHA, VA, Fannie or Freddie guarantees.
Over the last five years, with the global financial markets awash in money seeking any investment with a decent return, the loans that were funded and sold in these pools got riskier and riskier. This situation meant lower credit scores, higher loan-to-value ratios, interest-only and even negatively amortizing loans. At the same time, the premiums required by investors to accept this risk, in the form of higher rates and fees, got skinnier and skinnier until anyone with a pulse could qualify for a big loan with great terms and tiny payments.
That laxness all stopped last week. For the last several months, as subprime delinquencies and foreclosures grew at a far faster rate than Wall Street anticipated, the market for those loans dried up and underwriting guidelines got much tighter. The major headlines here were the near overnight bankruptcy of New Century Financial, one of the largest subprime lenders in the country, and the failure of two subprime mortgage hedge funds run by Bear Stearns. For most Americans, this fallout was a concern, but not too much of a concern. After all, most of us have good credit and never rely on subprime loans.
Which brings us again to last week. Within a matter of four days, American Home Mortgage, the 10th-largest wholesale lender in the United States, announced margin calls, had trading of its stock halted and finally filed for Chapter 11 bankruptcy-court protection to wind down its business. The big news here was that American Home Mortgage didn't deal in subprime loans. The company primarily was an Alt-A lender. Alt-A loans fill in the grey area between prime and subprime loans, usually due to some combination of high loan-to-value and limited documentation. When the media references "exotic loans," they are generally referring to Alt-A loans.
The AHM implosion was the spark that lit the fuse of this meltdown. Within days, investors on Wall Street who were paying 101% to 102% of the value of mortgage-backed securities stopped bidding entirely. They wouldn't buy them for 90%, 80%, or even 50% of their value. Most mid-sized mortgage banks have been forced to stop funding loans until buyers resurface for these loans. Larger lenders with the capital to hold loans in their portfolio for a period of time, most conspicuously Wells Fargo home loans, responded by raising rates on these loans by 1-1.5% overnight.
To put this situation into dollar terms for you, consider that a client of mine qualified for a $1.3 million dollar purchase loan. These are good buyers with a 25% down payment, good credit and full documentation. I initially quoted these borrowers 6.375% on an interest-only loan to give them a payment of slightly more than $6,900 per month. Within two days, the best rate on this type of loan jumped to 7.25% and the payment spiked to $7,850, an increase of $950 dollars. Even loans of half this amount would have seen a similar rate increase and a payment leap of $400 to $500 per month.
What Does This Mean to YOU? The answer to this question depends on your circumstances. For all homeowners, the rapid increase in the payments required to finance a home will likely speed the fall of home prices throughout the country, especially high priced and so-called "bubble markets."
If you have a fixed rate mortgage and plan to live in your home for an extended period of time, you probably have no need to worry. The mortgage market will correct to more normal levels and the impact on you should be minimal.
If you have an adjustable rate mortgage, especially an Option ARM loan with a negative amortization feature, or a hybrid loan with a fixed period ending in the next 18-24 months, you should consult with your mortgage professional to see what options currently exist for you, and to formulate a game plan for avoiding a rate and payment spike, or worse, in the near future.
If you have a subprime loan, run, don't walk, to see your mortgage professional. You need to understand your situation and all of your options. The situation is just too complex to try to figure out on your own.
For anyone who does not have a relationship with a trusted mortgage advisor, or would simply like a second opinion, please call me at 888.944.JOSH (5674) or e-mail me here. I can analyze your current financing, your needs moving forward and create a game plan to give you the peace of mind you require in these uncertain times in the market.
INTERESTED IN 8-12% YIELDS? 2
The big sell off in the stock market has created a lot of opportunities for income investors. I can't get into all the details in here in the Alert, but I do have a complete presentation for you I call Creating Passive Income. It's my latest live workshop, and it now is available online.
All you have to do is click here for all of the details on how you can listen to one of the most important seminars to your wealth that you will ever see.
In this unique workshop event, Josh Lewis -- my mortgage and real estate expert -- and I team up to show you the keys to creating the passive income you need to create the life of your dreams.
You will discover:
- How much passive income you really need
- The many sources of passive income
- 10 Investment Opportunities to generate 8-12% or MORE in annual yield
- The innovative new investment vehicles that provide the passive income you need month after month
- How to leverage highly appreciated real estate to accelerate your wealth building
- How to optimize your personal finances for greater simplicity AND greater returns
- How to get Uncle Sam to assist in your wealth-building journey
- The strategy used by the affluent to safely and conservatively build wealth
For more on how to download this seminar right now, simply click here.
BLOGS AWAY 10
I am continuing with my new audio blog segment on ETFs, which I call "ETF Talk." This segment is all about my favorite investment tools: exchange-traded funds. I just returned from the San Francisco Money Show and my ETF workshops there were packed. This tells me that investors want more education and a greater understanding about what I clearly think is the future of investing.
Join me today for my new series on ETFs, since I will be highlighting the latest ETFs that you can use to supercharge your portfolio.
To listen to the audio blog, simply click here.
WEALTH COACHING WITH DOUG
The coach is back from a very fruitful trip to the San Francisco Money Show, and I am happy to report that many of the attendees took me up on my offer and scheduled coaching sessions with me.
If you are feeling uneasy because of this stock market decline (and who isn't?), or if you don't have a clear roadmap designed to help you reach your retirement destination, I can help.
I invite anyone concerned with his or her investment situation to contact me at Fabian Wealth Strategies, my fee-only investment advisory firm. Our management fees vary depending on the scope of your needs, and our prices start at just $500.
For more information on how to schedule your very own coaching session, call David Fabian at 800.391.1118, or e-mail him.
RANDIAN WISDOM
"Achieving life is not the equivalent of avoiding death."
—Ayn Rand, novelist/philosopher
If you really want to achieve the life you desire, you have to be intrepid enough to go for it! I always keep in mind the above quote from Ayn Rand, who in my mind was one of the greatest novelists and one of the greatest thinkers the world has ever known. You see, there's no nobility in merely existing. To make your life a real value to you and to others, you have to strive to be the best you can be. Sure, the path will be difficult and fraught with struggle. But nothing good in this world is achieved without a whole lot of effort. Do yourself a favor and expend that effort no matter what the cost. Your life is up to you. Go live it!
Wisdom about money, investing and life can be found anywhere. If you have a good quote you'd like me to share with your fellow Alert readers, send it to me, along with any comments, questions and suggestions you have about my radio show, newsletters, seminars, or anything else.