The Morgan Stanley Solution: Refi of Non-Conforming Loans as Silver Bullet
David Greenlaw & Ted Wieseman
>Climbing Down from the Ledge: We continue to forecast growth near 2% over the four quarters of 2012, with a sub-1% reading in 2Q12, assuming expiration of the payroll tax cut. Bear case recession risks remain significant, but it has been encouraging that US growth has slowed but not rolled over in the past two months. And while the crisis in Europe has worsened, there are at least now potentially important plans being formulated to try to support the European banking system and avoid a deepening European credit crunch that would likely have substantial further negative knock-on impacts on the US.... [S]eptember's results have talked us down off the ledge.... The employment data are key at this stage of the economic cycle because productivity growth appears to be experiencing some underlying moderation. This is quite normal a couple of years into economic recovery, but the deceleration now is likely being exacerbated by extremely low net business investment over the past three years. So, we need income support from the labor market in order to sustain domestic demand and output.... While this [employment] report was much better than consensus expectations, it still points to a weak labor market.... If this trend continues, we are likely to soon see a slow but steady rise in the unemployment rate - especially after factoring in the ongoing declines in state and local government jobs. Assuming a stable participation rate, the economy needs to generate about 125,000 jobs per month just to keep the unemployment rate steady. Unless job growth starts to improve, we could be back near a 10% unemployment rate in 2012.
>Continued fiscal gridlock will mean that the problem of dealing with a faltering US economy will be left at the doorstep of the Federal Reserve. The Fed is not out of ammunition but the options that appear to be available at this point are not all that exciting.... We remain convinced that the best option available to the Fed at this point is to team up with the Treasury Department for a streamlined mortgage refinancing program. We estimate that nearly half of outstanding agency-backed mortgages that are still current do not meet standard qualifications for a refinancing because they have a loan-to-value ratio in excess of 80%. Moreover, the share of mortgages that are blocked from a refi has started to rise quite a bit in recent months. This means that much of the economic stimulus associated with declining mortgage rates is not making its way through the pipeline.
>In our view, two things will have to happen to bring about implementation of a streamlined refi program. First, the FHFA will have to take a broader view of its responsibilities in regulating the GSEs. Second, mortgage rates will have to continue to move lower, making the potential benefit of a refi wave more and more obvious. We suspect that these developments will play out over the course of time, but we are probably still months away from outright action...
