Don't Burn the Bridge Until We Cross

I'm holding on with both hands and both feet, oh
Promise that you won't pull the rug out from under me
Are you a heartbreaker?

-Pink

As part of the Fed's FOMC announcement due tomorrow, it is expected to announce the winding down their MBS purchase program, whereby the government has been buying mortgage paper in the marketplace. One can see how this has supported the mortgage market by helping to keep interest rates low. While I applaud the Fed's efforts to begin reining in certain stimulus well before we see the "whites of the eyes" of inflation, breaking the hearts of homeowners does not seem the correct course of action today.

With the president set to propose significant and lasting changes to the Fannie/Freddie model early next year, now is not the time to be pulling back on housing stimulus programs. All things being equal, however, we may be at the beginning of new housing troubles as the private sector is not yet ready to pick up the slack for these programs - not until uncertainty around the twins is greatly diminished.

Today, some 85 percent of new home mortgages are touched by the government in some way - primarily they are insured by Fannie or Freddie. But the twins are facing mandated reductions in portfolio size later this year which begs the question: who will lend to the marginal homebuyer?

Private lenders have shied away from this market for rational and irrational reasons alike. But no matter the reason, they simply aren't there. Looking at housing statistics, it seems we may be at a plateau of sorts in terms of homes for sale and prices. This is very good news compared to the last 24 months or so, although the housing market remains quite fragile.

So, why are the private lenders continuing to shy away, if it seems we've hit bottom? I argue it's because of the tremendous uncertainty about where the twins will play in this market going forward. In addition to the 85 percent of new mortgages they affect, they are responsible for some 55 percent of total mortgages outstanding - a number that is obviously increasing. To put it lightly, they are the 800-pound gorilla in the mortgage market.

Add to this the fact their fate is entirely in the hands of our government and one can see the great uncertainty that lies ahead for the mortgage sector.

Until our government answers a multitude of questions with regard to Fannie and Freddie, the mortgage market will remain on life support with little interest from the private sector. While long term the mortgage market remains very attractive, we will only see private investors back in force once they know where the gorilla will play.

Let's keep this market on government meds until we see some interest by the private sector.

Key Developments

Retail sales jumped 2.7 percent in August due primarily to the Cash for Clunkers program; however, stripping away auto sales, this measure rose an impressive 1.1 percent. The 1.1 percent increase in core sales was the largest increase since February 2009 and helped fuel a stock market rally last week.

Both CPI and PPI for August were released last week with neither showing signs of impending significant inflation. Driven by recent fluctuations in energy costs, these measures seem to have fallen by the wayside as few investors are seriously concerned about inflation in the near term.

Both the Philadelphia Fed Index and New York's Empire State Survey rose for the second month in a row, providing further proof the manufacturing sector is bottoming. While significant growth may not be in our near future, a leveling out of these sectors bodes well for employment stability in the near future.