Yesterday US Treasury prices improved price-wise (and rates dropped) after Standard & Poor's said it may cut credit ratings on $12 billion of bonds backed by subprime mortgages, raising concern housing weakness may slow the U.S. economy. The fear over subprime issues is huge, and although analysts suspected that the credit rating agencies were partly to blame, S&P, Moody’s, and Fitch have done very little up to this point.  What we saw was the traditional “flight to quality”, since every time credit spreads go up people buy Treasuries since they are judged to be free of default risk. Mortgage prices, however, did not improve that much (and in fact are slightly worse this morning) since there is an element of risk with every mortgage and investors are shying away from risk.

But possibly the bigger news is that S&P said that it would change its methodology for ratings hundreds of billions of dollars in residential mortgage-backed securities, and review its ratings on hundreds of billions of dollars in the more complex collateralized debt obligations based on those subprime loans. It is expected that a lot of debt will be downgraded to junk status and may have to be sold at fire-sale prices. Therefore many pension and hedge funds that once thrived on the high returns they could get from investing in subprime junk are expected to lose a lot of money. The effects of the US market shock have been felt around the world with German and Japanese debt markets rallying from the news and expectations for a Fed overnight rate cut this year have moved back up to 22%.

Lastly, FHLMC forecast that U.S. home sales in 2007 will decline to their lowest since the start of the five-year housing boom in 2001 as mortgage rates and foreclosures increase. Are we having fun yet?

What are mortgage brokers doing to decrease the number of loan repurchase requests? Although this isn’t much of a surprise, according to a poll by Inside Mortgage Finance, 63% are now using automatic desktop underwriting systems, 60% are doing VOE’s, and most others have beefed up verifications, credit checks, documentation, and quality control measures.