Quick glance at yield curve changes tells central bank story

One way to look at the relative easing of central banks is to track the shape of the yield curve over time. This is also a good way of telling what point we are in the business cycle.

The US market has moved from being flat to upward-sloped to the tune of close to 200 basis points. There has been the most easing in the US and the threat of a recession has been the greatest.

The Canadian market has followed a similar pattern from flat to upward sloping but in a more muted fashion which is similar to what we are seeing in the Canadian economy, less decline off in growth and less aggressive easing.

Great Britain has gone from downward sloping to something that is upward sloped. The Bank of England has been working to solve the credit crisis but has stopped short of moving into a full throttled ease.

Europe like the US had almost a flat curve between 10-year and 2-year yields, but has moved to an upward slope. The ECB has been less aggressive than the US and has stated that it has every intention of focusing on price stability.

Japan has been somewhat insulated from the credit issues and has seen a stable yield curve with little change in the curve. With a new Governor of the Bank of Japan coming into office it seems like monetary policy is on hold.

Those countries which have been less aggressive with their monetary policy have seen strengthening of their currencies. The currency markets have followed closely a monetary model of exchange rate determination although the monetary driver has not shown up in monetary growth levels.

Mortgage forgiveness proposal

Fed chairman Bernanke has moved beyond the usual monetary policy tactics of cutting interest rate to propose some form a mortgage forgiveness be given by lenders in a speech before the Independent Community Bankers of America Annual Convention, Orlando, Florida.

http://www.federalreserve.gov/newsevents/speech/bernanke20080304a.htm

After describing the current market situation, Bernanke got down to the focus of his current thinking.

This situation calls for a vigorous response. Measures to reduce preventable foreclosures could help not only stressed borrowers but also their communities and, indeed, the broader economy. At the level of the individual community, increases in foreclosed-upon and vacant properties tend to reduce house prices in the local area, affecting other homeowners and municipal tax bases.

In cases where refinancing is not possible, the next-best solution may often be some type of loss-mitigation arrangement between the lender and the distressed borrower. Indeed, the Federal Reserve and other regulators have issued guidance urging lenders and servicers to pursue such arrangements as an alternative to foreclosure when feasible and prudent.

Of course, the words forgiveness was not actually used but a simple NPV argument. If the cost of cutting payments is less than the cost of foreclosure then mortgage bankers should not foreclose. There is general agreement that this will work. The issue is whether legal documents and accounting rules can make this happen easily.

The actual action the Fed can take in controlling the credit adjustment process is limited as stated by the chairman.

The Federal Reserve can help by leveraging three important strengths: our analytical and data resources; our national presence; and our history of working closely with lenders, community groups, and other local stakeholders.

Urging is not very strong action.

I urge the Congress and the GSEs to take the steps necessary to allow more potential homebuyers access to mortgage credit at reasonable terms.

Nevertheless, this is an important speech in setting a tone of what the Fed believes should be done in the housing market.

Economic behavior and homeownership

NYT article on homeowners has a good quote on the impact of negative equity on homeowner behavior. “When homeowners do not have skin in the game, they act like they do not have skin in the game.”

We should not be surprised that behavior will change when economic incentives and costs change. If there is declining or negative equity, there is less likelihood that homeowners will do whatever it takes to avoid delinquency or foreclosure.