What are we going to do when the Fed stops buying mortgage-backed securities (next March)?  The spread between mortgage and Treasury yields – 1.90% at last count – is at risk.  When the Fed stops buying, will the spread soar (it was 3.50% at its widest in 2008)?  Maybe.  Just in case, PIMCO’s Bill Gross has lightened up on his mortgage holdings, and you ought to be preparing for higher rates in case they come.  Call me for some ideas.

For most borrowers, only one lender of consequence remains: the federal government.  The Fed has purchased net $900 billion of mortgage securities so far this year.  That’s a big number, especially when you consider that slightly more than $1 trillion of mortgage have been originated.  “Absent government intervention, there would be no lending,” said the director of Harvard University’s center for housing studies.  The government’s newly dominant role – nearly 90 percent of all new home loans are funded or guaranteed by taxpayers – has far-reaching consequences.

In the meantime, rates keep dropping.  We’re almost back to the levels we saw prior to the run-up in rates last June, and with conforming rates below 5.00%, a refinance boom has begun anew.  History shows the Fed is likely to keep rates low for a year or more.  They didn’t boost rates after the 2001 recession until 12 months into the recovery, while it was 17 months following the 1991 economic contraction.  Bernanke and crew “believe that accommodative policies will likely be warranted for an extended period.”

You can thank weak economic data this time around; Friday’s jobs report was downright awful.  7.2 million jobs have been lost since December 2007, and a record 15.1 million people are officially looking for work.  Add in some 9.2 million involuntary part-timers, and the jobless total swells to over 26 million. September was the 21st month in a row of shrinking employment, the longest losing streak since the monthly numbers started being published back in 1939, reports Barron’s. Private employment is now 2.6% below where it was at its December 2000 peak.

Popular wisdom predicts a weak economic recovery, but popular wisdom could well be wrong (as it often is).  “The recovery will be a bit of a barn burner,” predicts Jim Grant.  Economic growth is likely to surprise by its strength, not weakness, in spite of all of the negative news.  Hundreds of years of economic history have been consistent:  the worse the recessions, the more brisk the recoveries.  To wit, following the recession of 1981-82, the Reagan recovery rushed along at annual growth rates over the next six quarters of 5.1%, 9.3%, 8.1%, 8.5%, 8.0% and 7.1%.

Obama and Reagan differ dramatically, but the current administration does not lack for stimulus.  In the post World War II era, the government has attacked recessions with an average stimulus of 2.9% of GDP.  This time, stimulus is likely to measure 19.5% of GDP.  “Our Great Recession would be marked for greatness if for no other reason than by the outpouring of federal dollars to repress it,” remarked Grant.  For the record, the government has spent $3.9 trillion, which is more than the total of all U.S. government spending from the founding of the USA to 1974, almost 200 years.  “Fiscally, we are in uncharted territory,” claims Warren Buffett, master of the understatement.

Growth is likely to surprise, but not so much for housing prices.  Housing prices are expected to languish for years, and aren’t expected to regain 2006 levels for at least another decade, according to Moody’s.  The national housing price index is expected to fall 40% from the 2006 peak, bottoming in the middle of next year.  And that’s the rosy outlook.  After the Great Depression, national housing prices took nearly 20 years to return to the peak.  Housing prices in Japan lost 50% over 15 years ago; they haven’t recovered yet.

In other news… Officials have learned that some Al Qaeda suicide bombers, in an effort to avoid detection are hiding explosives inside their buttocks.  Here’s my question.  At what point in the planning of these attacks do they tell the suicide bomber?  I mean you got these guys. ‘OK, boss, I’m ready to be a martyr. I’m ready to die for my cause. Where’s my dynamite vest?’  ‘Listen, Khalid, we’ve made some changes.’”  – Jay Leno

Thanks for your business and have a good week.            — Tom Millon