MARKET RECAP

Optimism received a shot in the arm last week, for there was much to like in both the stock and real estate markets. First, the Dow Jones Industrial Average soared a whopping 889 points on Tuesday in anticipation of the Federal Reserve lopping the fed funds rate to 1% (which it did). Investors, sensing a market bottom, began buying stocks in a piranha-like frenzy.

More bargain hunters are appearing in the housing market as well. The week before last, the NAR reported that existing homes sales rose sharply in September to the highest level in 13 months. This week, the Commerce Department reported that new home sales rose 2.7% to an annualized rate of 464,000 units (albeit after dropping by a steep 12.3% in August). The median sale price for a new home fell to $218,400, its lowest level in four years. But that's not necessarily bad; lower prices stimulate demand while constricting supply.fed

Recent housing data indicate that a bottom in home sales might be taking hold, and that could pave the way for an eventual rebound. But let's not get too far ahead of ourselves quite yet. The stabilization of home sales reflects buying conditions in July and August, which could be threatened by the deeper economic woes we've seen in late September and October.

That said, optimists can take additional solace in the fact that the bad news wasn't all that bad. The Commerce Department also reported that gross domestic product, or GDP, decreased at a 0.3% annualized rate in the third quarter, the biggest third-quarter decline since 2001. However, the decline is less than the 0.5% decrease that most pundits had expected.

Mortgage rates last week is one bone we can throw the pessimists' way. They climbed to the highest level in three months, based on Bankrate's national survey. On that front, the prime 30-year fixed-rate mortgage rose 45 basis points to average 6.77%, the prime 15-year fixed-rate mortgage rose 53 basis points to average 6.46%, and the prime 5/1 adjustable-rate mortgage rose 18 basis points to 6.67%. Still, it’s worth reiterating that primary mortgage rates remain low by historical standards.

Liquidity and Lending

What's the deal with liquidity, and why is everyone talking about it? Long-dead economist Irving Fisher noted that MV=PT, where M is money, V is velocity, P is price level, and T is transactions. The equation represents gross domestic product. In short, the Federal Reserve is focusing on the M part of the equation because the V part, velocity (or the number of times money changes hands), is slowing. Increasing the money supply (liquidity), in theory, will stabilize the economy.

So far, the theory is holding. The world is progressing against financial panic. Capital – private and public – is flowing into the banking system, while the Fed's new commercial paper facility has helped to reignite a vital source of corporate funds. Meanwhile, the Treasury Department's direct bank investments are restoring confidence in these institutions.

Confidence (a constant refrain in these missives) is what's needed now. In theory, the Treasury Department's $250 billion in direct bank investment could permit $2.5 trillion in new lending, given 10-1 leverage, if the banks believe the worst is over and begin lending against their expanded capital base.

The good news for the mortgage market is that when banks increase their mortgage-lending allocation, they'll find a willing buyer. Both Freddie Mac and Fannie Mae have the capability to buy more than $200 billion in mortgages before hitting their $850 billion annual portfolio cap. With Freddie Mac a net seller of mortgage-backed securities in recent months, many pundits expect both institutions to pick up the mortgage-buying pace over the next two months.