We’re looking at a fool’s rally - plain and simple.

Wall Street has a phrase for a short-lived rally of a stock on the way to the tank: Fool’s Rally.  Speculators try to “time” the stock and put in a temporary, artificial bottom by increasing demand through rapid buying.  This pushes stock prices back up for a brief moment at which point the bulls and other optimists call bottom and start to hint that maybe everything will be fine again.

The Mortgage Equivalent of a Fool’s Rally

We all know that it’s called a fool’s rally because people buying in to it are looking at a big loss as the stock returns to its downward trajectory; eventually finding a permanent bottom.  It is my opinion that the mortgage “mini-boom” we’re seeing right now is such a red herring.

Rates are low - allowing the best-qualified, best-documented borrowers who didn’t tap every last penny of equity to lock in a low, low rate.  Mortgage brokers rejoice!  The tide is turning the loans are rolling in through the door and the pipelines are full.

Alas, this boom is unsustainable and does not signal the bottom of the mortgage industry’s ills.  Has anyone been reading the news lately?  Citi, Merrill, JP Morgan, Wells, WaMu, Lehman - the beat goes on.  We’re still on the down escalator and we may be picking up speed.

Recession Imminent

Nouriel Roubini, the former White House economist is raising the alarm in a manner that might surprise you for this housing bear.  Roubini is calling for the Fed to cut rates faster to avert a systemic meltdown and a long, hard recession.

 The growing glut of unsold homes, big-ticket consumer items and autos implies that Fed easing will have only a limited effect on the rapidly sinking economy. Whatever the Fed does will be too little, too late to stop the recession altogether. But this does not imply that the Fed should allow massive unemployment to emerge just to teach a lesson to Wall Street and avoid a “bailout” of investors.

So Why the Confusion?

So why the confusion in the marketplace?  Why are the most respected economists signaling recession while mortgage brokers and lenders are signaling some return to “normalcy”?  Because we’re experiencing a fool’s rally.  The argument that banks are taking bigger-than-necessary losses to “purge” the system is laughable.  Nearly a quarter ago banks were giving that same argument as they took “conservative” positions to “purge” the system.  Banks can’t take conservative positions on write downs because no one knows what this stuff is currently worth.

Prime borrowers who have conforming loan limits with fully documented incomes may be getting great rates; but the secondary market is still non-existent and jumbo loans are either non-existent, on the endangered species list or impossible to qualify for.   And therein lies the problem.  An obscene amount of home loans are well over the conforming loan limits that are soon-to-be adjusting into a market that has no place for them.

And lower rates will not matter to those people.  Their ARM rates that are set by obscene margins.  Interest rates would need to be close to zero for them to have a shot at affording their adjusting payments.  And even at 1% their rate could still adjust higher!

This pain will continue to be felt.

Hold on to Your Butts

Those that buy in to this fool’s rally will be in trouble.  Do I recommend taking advantage of it if you’re in the business?  Absolutely.  Should you bet your money on this rally?  Absolutely not.

We’re looking at plenty of pain to come.  The mortgage industry is not done feeling their fair share of it.  Guidelines continue tighten, wholesale lending continues to be curtailed, eliminated and neglected.  Loans will continue to become harder; smaller operators will bear larger costs of doing business while witnessing smaller per-loan profits.  The big banks will monopolize the marketplace and the vetting will continue.

That you can bet money on.

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