Larry Summers quit as economic advisor in the Obama Administration - the third high-level member of Obama's economic team to leave in recent months (after budget director Peter Orszag and Christina Romer, head of the Council of Economic Advisers) This leaves Treasury Secretary Geithner would be the only one of Obama's top-tier economic advisers to remain in the fox hole. Markets don't like uncertainty, but so far this news has had no direct impact on mortgage rates.

Originators often wonder what goes into the price (and value) of a mortgage. (If you don't, then you can skip ahead to the joke, which is good today.) Lately the implied value of servicing has been dropping - but could it also be that investors are backed up and looking to slow production by increasing their profit margins?

Before anyone says that the value of servicing is next-to-nothing, don't forget to consider investor profit margins. And while you're at it, give some thought to the theory that investors with large servicing portfolios would probably rather not create an environment where it makes financial sense to have dozens and dozens of companies servicing their own loans. Who needs the competition - so why would servicing investors drive the value of servicing to zero, pushing companies toward servicing their own loans? Just some thoughts...

"Servicing values have been relatively stable, and perhaps even improved a little, over the past year.  This is for several good reasons; the credit quality of this year's book is probably the best in a decade; rates are at all-time lows, so investors can expect a long life; the real estate market has stabilized to a degree; and servicing is slowly beginning to trade in bulk again, improving liquidity.  Although investors are putting decent values on servicing, they are actually a little lower than they were 5 years ago, and there are very good arguments that the economic value of this year's book may be much higher than the market values being assumed." -Tina Reid-Freeman of MIAC.

She continues. "Then there is the issue of how much is being paid for the servicing by the conduits.  This can be defined as the difference between how much cash you could get if you sold the loan directly to Fannie or Freddie in a security, and how much cash you can get selling it servicing released to a conduit.  So if you could have securitized a loan for 102 and you sell to Wells at 102.50, you just sold your servicing for 50 basis points, a 2X multiple of the standard 25 basis point servicing fee.

"The amount paid is based almost purely on supply and demand and has next to nothing to do with values. Historically, without fail, the amount of cash paid on rate sheets over the securities price goes up when rates go up and goes down when rates go down.  This is purely based on competitive factors, and has absolutely nothing to do with value.  When pipelines are full, investors take the all-in value of the loan, including servicing value, and take out a bigger profit margin not because the servicing is worth less but because they can. When volume is down, there will be intense pressure to keep the plants running, and the amount paid for loans (and therefore the net cash payment for the servicing) goes up!

"So in its own perverse way, the secondary market pays the most for servicing when rates are high and volume is low - and the least when rates are low.  This is the opposite of what the obvious economic valuation argument should be...low rate servicing stays longer and is worth more.  High rate servicing is worth less, on an economic basis.

"This is why we encourage all of our servicing-released sellers to have the ability to retain servicing when it is economically prudent. There are many, many cases in today's market when servicing is being 'given away' for very little, or even nothing, and in some cases even less than nothing (i.e., rate sheet price is below securitization value so the seller is paying to give away his servicing rights!!)  There is no reason to give away this asset, particularly when there are very good subservicers out there and you don't even need to deal with the operational burden!"

Thank you Tina!

Which reminds me: last week I discussed hedging manager's decision making with regard to direct trades versus AOT execution. A principal of Charbonneau Inc. wrote, "No matter what delivery method is used, or how companies hedge, lenders should always have a top-notch CPA take a look. I have seen numerous examples of mis-allocated hedge costs, income missed, or expenses uncounted."

A secondary marketing manager with Opes Advisors wrote, "When choosing between AOT or Direct Trades, I consider several things. The largest hurdle that I have in using AOT's is the lack of available broker-dealer lines. The industry has had several broker/dealers exit or curtail business the last couple of years, and mortgage banks are faced with posting margin on deposit as restricted cash at broker dealers, dealing only with those who self clear or who don't require margin, or hedge only using near-month securities which don't cover long-term locks. And only selling in the front month severely limits the ability to do AOT's. On top of that, fitting tail pieces in AOT's is a nightmare with large loan amounts."

Fannie Mae has issued "Announcements" on "Home Affordable Modification Program - Introduction of the Second Lien Program" and "Updates to Fannie Mae's Forbearance, Income Eligibility, and Home Affordable Modification Program Requirements". Probably best, if you're interested, to read them yourself HERE

Rates, and stocks to some extent, both had a good day Tuesday. Things were pretty quiet  leading up to the FOMC's announcement. Overnight rates were left unchanged (and besides, there is little correlation between overnight rates and 30-yr Treasury, or mortgage, rates), but the Fed's statement was viewed as "dovish" as it talked about its mandates and reminded us that inflation is under target - it's too low for economic growth. The Fed is "prepared to provide additional accommodation if needed".

The verbiage took some uncertainty out of the market - and few markets like uncertainty. This statement leaves no doubt that further easing is on the table; however, it still may take some time for the Committee to debate the details and hash out a compromise. Some analysts expect that by January, the FOMC will be ready to announce a plan for a sizable purchase of longer-dated Treasuries. (There was nothing about buying more mortgages.) It is worthwhile to note that Chairman Bernanke, a scholar of the Great Depression, has observed that wholesale prices had good predictive value during the Depression.  Therefore a sustained downturn in producer prices is likely to make him pretty nervous.

Folks who analyze the markets believe that the odds are very slim of any kind of Fed tightening in 2011. Of course, lower rates lead to more prepayments, which in turn lead to more runoff from the Fed's MBS portfolio, which in turn currently leads to more Fed buying of intermediate Treasuries! A second round of quantitative easing ("QE2") may happen if the economy falters going forward. But for now, yesterday's rally brought mortgage rates back to where they were last Tuesday, which was the best day to lock last week, and MBS's closed the day better by about .5 in price. Only $1 billion in mortgages crossed the MBS tape - about half of normal.

This morning we learned, thanks to the MBA, what lock desks already knew: mortgage applications in the U.S. declined last week for a third consecutive time. The weekly index fell 1.4% to the lowest level in six weeks, with purchases down 3.3% and refinancing down .9% percent. (Refi's are more than 81% of applications.) Aside from that, we have no news coming out, and we find the 10-yr back down to 2.53% and mortgages better by about .125.

According to a news report, a certain private school in Washington was recently faced with a unique problem. A number of 12-year-old girls were beginning to use lipstick and would put it on in the bathroom. That was fine, but after they put on their lipstick, they would press their lips on the mirror leaving dozens of little lip prints. Every night the maintenance man would remove them, and the next day the girls would put them back. Finally the principal decided that something had to be done.

She called all the girls to the bathroom and met them there with the maintenance man. She explained that all these lip prints were causing a major problem for the custodian who had to clean the mirrors every night (you can just imagine all the yawns from the little princesses).

To demonstrate how difficult it had been to clean the mirrors, she asked the maintenance man to show the girls how much effort was required. He took out a long-handled squeegee, dipped it in the toilet, and cleaned the mirror with it.

Since then, there have been no lip prints on the mirror.

There are teachers...and then there are educators.