The markets were set for positive news on Monday with the expected passage of the government's Emergency Economic Stabilization Act of 2008, which includes the Troubled Asset Relief Program (TARP).
Lawmakers worked long hours all weekend to develop a plan that was palatable to both sides of Congress. Instead, what the markets got was a stunning defeat of the bill by 228-205 as a large number of House Republicans voted against it.
The Dow plummeted 777 points - a record drop.
With global liquidity frozen again, the Federal Reserve and central banks from all over the world worked together to inject liquidity into the global markets as credit seized up ahead of Congress' vote on TARP.
Initiatives taken by the Fed included an increase in the size of the 84-day maturity TAF auctions to $75 billion per auction from $25 billion beginning with the Oct. 6 auction; two forward TAF auctions totaling $150 billion to be conducted in November to provide term funding over year-end; and a $330 billion expansion in its swap lines with the Bank of Canada, the Bank of England, the Bank of Japan, the National Bank of Denmark, the European Central Bank, the Bank of Norway, the Reserve Bank of Australia, the Bank of Sweden and the Swiss National Bank.
Mortgage volume was below normal on Monday as many participants waited on the House vote. The day started off with spreads just slightly wider to the curve and tighter versus swaps. Spreads steadily widened on selling from money managers, banks and originators into mid-morning, but buyers emerged on the widening. That vanished, however, mid-afternoon when the government's bailout was defeated. Spreads ended the day wider to the curve by 15 ticks in 5s to 14 ticks in 6s and by 11 ticks in 6.5s.
Tuesday had a more positive tone as various government officials in the U.S. assured the nation, the world and the markets that a bill would get passed. Equities rallied 485 points on the Dow as a result of these expectations, while the 10-year Treasury lost all of Monday's gain. The improved tone came despite more news on global bailouts: Belgium, France and Luxembourg bailed out Dexia, the world's biggest lender to local governments, with a $9.2 billion injection; German commercial property lender Hypo Real Estate received a $51 billion line of credit from various banks as well as the German government; the Icelandic government took over Glitnir, one of that country's largest lenders; Ireland announced that it would guaranty all the debt of its top six financial institutions, which amounts to around $563 billion in various bank debt; and India's central bank dealt with a run on deposits at the second-largest bank in that country by promising to pump cash into the institution.
Mortgages initially tightened on buying, including some month-end, but were increasingly pressured by active selling from money managers to move back into equities following Monday's cheapening on expectations of passage of a bailout bill, as well as news that the Securities and Exchange Commission (SEC) and Financial Accounting Standards Board (FASB) were issuing guidance on fair value accounting, which could actually help valuations on holdings where market valuations are not available. Spreads ended wider to the curve by two ticks in 5s and 5.5s, by a tick in 6s, and were tighter by two ticks in 6.5s.
Mortgage Applications Decline
The Mortgage Bankers Association reported that its Refinance Index declined 34.7% to 1333.9 for the week ending Sept. 26. In the previous two weeks, the index held above 2000 after falling to the low 1000s in August and early September as mortgage rates plummeted
after the government took over the GSEs. Further turmoil in the credit markets, however, forced mortgage rates back up. Purchase activity also declined further by 10.9% to 304.8.
For the month of September, the Refinance Index averaged 1725, up 64% from August's average of 1052. 30-year fixed mortgage rates averaged 44 basis points lower to 6.04%. Given the sharp increase, prepayments in October are seen spiking up.
As a percent of total applications, refinancing share was 44% compared to 51.6% previously. ARM share also declined to 3.3% from 4%.
Mortgage and Prepayment Outlook
Street analysts are upwardly revising their outlook on prepayments in the near term given the sharp drop in mortgage rates and the increased percentage of the mortgage universe with a decent rate incentive.
September speeds are projected to be lower by 2% in FNMAs and up 1% in GNMAs. Speeds were originally expected to slow more than this. However, some pull-through apparently is anticipated following the GSE takeover and the drop in mortgage rates. Other factors influencing speeds include lower refinancing activity in August and higher mortgage rates. The Refinance Index averaged 1052, down 18% from July's average. At the same time, the 30-year fixed mortgage rate averaged 6.48%, off five basis points from July's average. Day count holds steady in September at 21 days. The September prepayment reports will be out beginning Oct. 6, with paydowns estimated at $34 billion.
October speeds are forecast to jump 58% in FNMAs from September's average, about twice as much as previously predicted. GNMA speeds are forecast to increase about 21%. Mortgage rates averaged 44 basis points lower in September compared withAugust's average, while the Refinance Index was 64% higher. The month also has one extra collection day.
The largest percentage gains are in 2007 and 2006 vintages and in 5.5% through 6.5% coupons. Premium coupon speeds are expected to be impacted, in part, by increased buyout activity from the GSEs, which has been on hold for some time as a result of their capital situation, as well as from delinquent refinancing through the Federal Housing Administration.
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