Clouds Over Economy Unlikely to Clear Soon

The U.S. economy is like an overcast fall day: neither hot nor cold, with a chance of worsening weather.

The cloudy state of the economy has put the Federal Reserve in a fix. The central bank seems increasingly willing to take another stab at stimulating the economy, but only if growth clearly appears to be faltering.

The game plan of the Fed will capture much of the economic spotlight this week as central bankers gathers for their annual retreat at Jackson Hole in Wyoming. Wall Street will be looking for clues on whether the Fed is ready to pull the trigger.

What could influence the Fed is another weak consumer spending report. Consumer spending has fallen two straight months, the first time that’s happened since the tail end of the last recession.

Earlier data on retail sales, however, suggests consumer spending rose modestly in July. Economists surveyed by MarketWatch forecast spending to rise 0.3% in July.

“Lower gas prices during the summer gave consumers a boost,” said economist Michael Gapen of Barclays Capital. “Income growth has somewhat improved and the savings rate has risen.”

The savings rate moved up to 4.4% in June from just 3.2% last winter.

What’s less certain is whether consumers will continue to spend at a modest clip over the rest of the year. The U.S. is not growing very fast, companies are reluctant to hire, the global economy has hit a rut and a political stalemate in Washington has businesses on edge.

Deep cuts in federal spending and higher taxes are slated to kick in on Jan. 1, 2013 unless Washington rescinds them, but chances of a compromise appear remote until after the presidential election in November

Treasury Changes Fannie and Freddie Bailout Deal

The government is changing the terms of its bailout agreement with Fannie Mae and Freddie Mac in a way that will shrink the holdings of the two mortgage giants more quickly and will require payment to the government of all quarterly profits the companies earn.

The Treasury Department announced the changes Friday in an effort to deal with concerns that the companies could at some point exhaust the federal support they were guaranteed when they were taken over by the government in September 2008 during the financial crisis.  The two firms would have to turn over all profits they earn every quarter. They would also be required to accelerate the reduction of their mortgage holdings to hit a cap of $250 billion by 2018, four years earlier than planned.  Under the new arrangement, the firms' portfolios can be no larger than $650 billion each at the end of this year.

The Obama administration unveiled a plan last year to slowly dissolve Fannie and Freddie, with the goal of shrinking the government's role in the mortgage system. The proposal would remake decades of federal policy aimed at supporting Americans' ability to buy homes and could make home loans more expensive. However, Congress hasn't yet decided how far the government's role in mortgages should be reduced.  Industry groups including the American Bankers Association and the Mortgage Bankers Association were generally supportive of the administration's action.

"Much more work needs to be done to reform the secondary market (for mortgage-backed securities) but today's announcement helps move this process forward and ensure the taxpayers' investment is ultimately repaid," Frank Keating, president of the banking group, said in a statement.

Currently, Fannie and Freddie make dividend payments to the Treasury every quarter. That has forced them to borrow money from the government and use that money to repay the government in periods when they didn't turn a large enough profit to cover the dividend payments. 

Under the new arrangement, the government will simply take all the profits that the firms make in any quarter as a dividend payment. The government will not require a dividend payment in periods when the firms run a loss.

So far, Fannie and Freddie have paid nearly $46 billion in dividends.

June Existing Home Prices Rise Again

Existing-home prices continued to show gains but sales fell in June with tight supplies of affordable homes limiting first-time buyers, according to the National Association of Realtors®.

Total existing-home sales, which are completed transactions that include single-family homes, townhomes, condominiums and co-ops, declined 5.4 percent to a seasonally adjusted annual rate of 4.37 million in June from an upwardly revised 4.62 million in May, but are 4.5 percent higher than the 4.18 million-unit level in June 2011.

Lawrence Yun, NAR chief economist, said the bigger story is lower inventory and the recovery in home prices. "Despite the frictions related to obtaining mortgages, buyer interest remains solid. But inventory continues to shrink and that is limiting buying opportunities. This, in turn, is pushing up home prices in many markets," he said. "The price improvement also results from fewer distressed homes in the sales mix."

According to Freddie Mac, the national average commitment rate for a 30-year, conventional, fixed-rate mortgage fell to a record low 3.68 percent in June from 3.80 percent in May; the rate was 4.51 percent in June 2011; recordkeeping began in 1971.

The national median existing-home price for all housing types was $189,400 in June, up 7.9 percent from a year ago. This marks four back-to-back monthly price increases from a year earlier, which last occurred in February to May of 2006. June's gain was the strongest since February 2006 when the median price rose 8.7 percent from a year prior.

Distressed homes - foreclosures and short sales sold at deep discounts - accounted for 25 percent of June sales (13 percent were foreclosures and 12 percent were short sales), unchanged from May but down from 30 percent in June 2011. Foreclosures sold for an average discount of 18 percent below market value in June, while short sales were discounted 15 percent. "The distressed portion of the market will further diminish because the number of seriously delinquent mortgages has been falling," said Yun.

Mortgage Lenders Easing Standards, But Not for Everyone

With home prices rising in many markets around the country, might mortgage lenders start loosening up their hyper-strict underwriting rules and extend loans to buyers who now find themselves on the sidelines? Could current preferences for FICO credit scores in the mid-700s, down payments of 20%-plus and tight debt-to-income ratios begin to ease a little, given the widely acknowledged fact that loans underwritten in the last several years have performed exceptionally well — that is, defaulted at low rates?

Maybe. A lower unemployment rate would help, say mortgage industry leaders, as would signs of more robust growth in the overall economy. But the industry is unlikely to go back to what Frank Nothaft, chief economist of Freddie Mac, called "the loosey-goosey standards we had in 2005 through 2007": minimal documentation of income and assets, zero down payments and a disregard for applicants' ability to afford payments on the loans they sought.

Fannie Mae is planning an overhaul of its automated underwriting system in October. Fannie's system plays a huge role far beyond its own business, since lenders often submit borrowers' application data through it to get a quick read on whether a loan meets the baseline tests for eligibility — even if the mortgage is destined ultimately for the FHA, VA or a bank's portfolio. Although Fannie Mae officials insist that the upcoming changes to credit risk evaluation and other factors won't significantly alter the percentages of approvals that the system generates, they concede that some applicants who are currently getting green lights for loans won't get them, and others who are currently on the margins will sail through.

Other signs that the lending industry may not be quite ready to loosen up: In the latest quarterly survey of banks conducted by the comptroller of the currency, 25% said they had tightened rules for mortgages in recent months, whereas just 10% said they had eased their standards. Two-thirds said their rules remained the same.

Also, a study by mortgage data firm Ellie Mae of new loans closed in June found that credit scores for approved mortgages remain extraordinarily high. Fannie and Freddie's refinancings had an average FICO score of 767 and average equity percentages of 29%. Home purchase loans had average down payments of 21% and 763 FICOs. Even the conventional home purchase loan applications that lenders rejected had high credit scores and down payments by historical standards: 738 average FICOs and 19% down payments.