Bloomberg is reporting MBA’s Mortgage Applications Index Dropped 4% as rates climb.

The interest rate charged for one- year adjustable loans jumped last week by the most since the Mortgage Bankers Association began keeping records in 1996.

The report demonstrates the difficulty some home buyers face in securing affordable financing. Banks, forced to hold loans rather than resell them as securities because demand has dried up, are charging higher rates for riskier mortgages. The housing slump will worsen as banks restrict the availability of credit and falling real- estate prices prevent owners from tapping home equity for extra spending money, economists said.

“If rates go up and credit gets tighter, that is going to lead to a drop in demand on top of what we have already seen,” said Abiel Reinhart, an economist at JPMorgan Chase & Co. in New York. “That is going to have an adverse impact” on the economy through the first half of 2008, he said.

The average rate on a one-year adjustable mortgage surged to 6.51 percent, the highest since January 2001, from 5.84 percent the prior week. The rate also surpassed the cost of a 30-year fixed loan for the first time.

The number of applications for adjustable-rate loans slumped 23 percent, while those for fixed-rate mortgages rose 0.2 percent. Adjustable-rate mortgages dropped to 15 percent of all applications, the fewest since July 2003.

Banks “are being very cautious in the volume of prime adjustables they are putting on their balance sheets,” Douglas Duncan, the mortgage bankers group’s chief economist, said in an interview. “The growth path for the economy has slowed significantly.”

The one year ARM rate exceeds the 30 year fixed rate. That’s pretty funny or do I mean scary?

There is no demand for junk. None. Nadda. Zip. And because there is no demand, the “pass the trash” play is over as well. Thus banks will have to keep mortgage loans themselves. In response, mortgage rates have soared. This is in spite of a rather sharp rally in treasuries.

The Punch Bowl Caucus Begs for Rate Cuts

So the Punch Bowl Caucus is begging the Fed to cut rates.

In the past week, a strange group has been pleading for the Federal Reserve to return the punch bowl to the toga party—to slash interest rates to restart the Wall Street party. The Punch Bowl Caucus, whose members hail from all over and hold different ideological views, share a common belief: [The Fed cut rates].

CNBC commentator James Cramer founded the caucus with his now-famous capitalist manifesto on Aug. 3. (He serves as honorary chairman of the Wall Street chapter.)

The Punch Bowl Caucus holds as an organizing principle that the Federal Reserve can provide a real and psychological boost to markets—and hence minimize or obviate entirely the fallout of natural economic occurrences such as asset bubbles and the business cycle. College students don’t alleviate the after-effects of an evening spent at the punch bowl by returning to lap up the dregs. Just so, finance types should know that cheap money, credit on demand, and endless leverage aren’t the cure for a hangover caused by too much cheap money, leverage, and credit on demand.

Punch Bowl Caucus Members

  • James Cramer – Punch Bowl Caucus Founding Father
  • Ford CEO Alan Mulally
  • Chrysler CEO Robert Nardelli
  • Wayne Angell, a former Fed governor wants a 75 basis point cut
  • CNBC’s Larry Kudlow seconded the motion by Angell
  • Angelo Mozilo, CEO of Countrywide Financial
  • Martin Wolf, chief economics commentator of the Financial Times, formed an international auxiliary

And no doubt the list is growing every passing day.

The 3 Month Treasury Discount Rate
Click on chart for a sharper image.

Look at the short end of the curve. For the last two weeks it has been ping-ponging between 2.4% and 4.5%. This is not normal action to say the least. The stock market may think things have stabilized but the bond market believes otherwise. It’s best to believe the bond market.

One month ago the 1 year ARM rate was 5.52. Today it is 5.97.
One month ago the 15 year fixed rate was 5.93. Today it is 5.74.

10 Year Treasury Yield Daily Chart

Click on chart for a sharper image

Mortgage Rates have clearly disconnected from treasuries and the further one gets away from conforming prime with a huge down payment the bigger the disconnect. There is no demand for subprime ARM paper as stated earlier. So most of those who are trapped in ARMs about to reset will benefit minimally if at all from the first few rate cuts. For my response to Cramer’s rant as well as more reasons and more charts on treasury and mortgage rates, please see Will Rate Cuts Save The Economy?

From Outer Space

While some are sipping too much punch, others are simply from outer space. Please consider Barack Obama’s radical mortgage plan.

Unscrupulous lenders who deceptively sold subprime mortgages to millions of Americans should be fined and the proceeds used to help bail out borrowers facing a wave of foreclosures, according to Barack Obama, the Democratic senator running to be his party’s presidential candidate.

Mr Obama blamed lobbyists working on behalf of lenders for obstructing tougher regulation of the subprime industry, adding: “Our government failed to provide the regulatory scrutiny that could have prevented this crisis.

“While predatory lenders were driving low-income families into financial ruin, 10 of the country’s largest mortgage lenders were spending more than $185m (€136m, £92m) lobbying Washington to let them get away with it,” he wrote, citing figures from the Centre for Responsive Politics.

Wall Street banks have also stepped up their lobbying over the issue of subprime lending as their underwriting practices come under scrutiny. It emerged this week that Citigroup paid $160,000 in the first half of this year for lobbying services from Ogilvy Government Relations.

Mr Obama said the government needed to “stop the unlicensed, unregulated, fly-by-night mortgage brokers who are hoodwinking low-income borrowers into loans they can’t afford”.

Rather than fix the original problem: Government sponsorship of GSEs, the ownership society, tax breaks for homeowners, HUD, 300+ bills to make housing more affordable, etc, etc, Obama points the finger in the wrong direction and wants still more ridiculous legislation as his solution.

Nonsense like this will not end until someone like Ron Paul is elected or the system completely breaks down in a massive tangle of intertwined bureaucratic legislation that collapses the economy. I am hoping it does not take the latter to achieve the former but the odds appear to be against me.

Mike Shedlock / Mish/