Question: Who determines interest rates?
Answer: The market.
This is an instructive article to help explain why further Fed rate cuts may not result in lower interest rates (highlights are mine and I have added some small editorialized remarks as well – just can’t help myself). If any of this does not make sense to you or if you would just like to discuss this so you feel educated enough to have a conversation with your friends or clients – give me a call and let’s chat.
Gary Gottlieb
707 328 3586
Bernanke Fails to Cut Rates for Most Americans With Easy Credit
By Kathleen M. Howley
Feb. 26 (Bloomberg) — Ben S. Bernanke, who has reduced interest rates faster than any Federal Reserve chairman since 1982, is failing to bring down the cost of credit for most American homeowners.
The average fixed rate for a 30-year home loan rose more than half a percentage point during the past four weeks to 6.04 percent (quoted with 1% origination point included), according to Freddie Mac, the world’s second-largest mortgage buyer after Fannie Mae. The increase occurred after the Fed lowered its benchmark rate by 0.75 percent on Jan. 22 and cut the rate by a further half-point eight days later.
When Bernanke faces Congress tomorrow and Feb. 28, he will be questioned about why long-term bond yields (and therefore mortgage interest rates) are moving in the opposite direction to the Fed funds rate, said Credit Suisse Group Chief Economist Neal Soss. Lower fixed mortgage rates would avert foreclosures and give consumers more money to spend, said Diane Swonk, chief economist of Mesirow Financial Inc. in Chicago.
“Chairman Bernanke is caught in a tug-of-war between growth and inflation,” said Swonk, who is a member of the Congressional Budget Office’s panel of economic advisers. “Inflation is still a threat and that influences the mortgage-bond investors who ultimately set the fixed rates.”
More than two-thirds of Americans own their own home (and many of them have NO Mortgage at all) , with total mortgage debt of $11 trillion, data compiled by the Fed show. About a third of the loans are adjustable-rate mortgages, according to the Federal Housing Finance Board. Nine out of 10 people with so-called ARMs who refinanced in the fourth quarter moved to a fixed-rate loan (smart people!), Freddie Mac said in a Feb. 19 report.
Greenspan’s ‘Conundrum’:
Three years ago, when former Fed Chairman Alan Greenspan testified in Congress, he faced a situation that was the complete opposite of what confronts Bernanke: long-term yields were declining as the Fed’s benchmark interest rate was rising.
“The broadly unanticipated behavior of world bond markets remains a conundrum,” Greenspan said in his Feb. 16, 2005, testimony to Congress.
This year, the Fed is lowering rates in an attempt to avert the first recession since 2001. The January cuts of 1.25 percentage points were the largest since August 1982 when the Open Market Committee slashed rates by 2 percentage points.
Bernanke and his colleagues have no direct control over mortgage rates. Fixed rates historically decline in tandem with Fed rate cuts that signal slower economic growth and a reduced threat of inflation, said Keith Shaughnessy, president of Foundation Mortgage Corp. in Littleton, Massachusetts.
Yield Spreads:
Right now, bond investors aren’t convinced that inflation isn’t a problem, he said. The yield of 10-year Treasury notes climbed to 3.88 percent from 3.43 percent on Jan. 22.
Investors in mortgage-backed securities guaranteed by government-linked entities such as Fannie Mae also are demanding higher yields over Treasuries and other benchmarks as competing investments offer greater returns. Spreads on so-called current- coupon agency mortgage securities, whose yields determine interest rates for prime loans below $417,000, have reached the highest since the 1980s (this is on what we call conforming loans) , according to UBS AG.
The extra yield that investors demand to own agency mortgage-backed securities over 10-year U.S. Treasuries rose to an eight-year high of 1.94 percentage points this week, up 0.59 percentage points from Jan. 15.
“Lowering fixed rates and making it easier to get a mortgage is the best thing Bernanke could do for housing, but it’s the one thing he has no direct control over,” Shaughnessy said. “The only thing he can do is try to reassure the market.”
Economic Outlook:
Fed officials cut their 2008 forecasts for economic growth by half a percentage point at the January meeting and said inflation picked up in the closing months of 2007, according to minutes of Fed meetings released last week.
A combination of slowing growth and higher inflation, so- called stagflation, will be in the spotlight as Bernanke testifies, said Credit Suisse’s Soss, who worked as an aide to former Fed Chairman Paul Volcker.
“It’s an election year, with all of the House and a third of the Senate up for grabs,” Soss said. “The temptation to second-guess policy makers will be visible.”
The average U.S. rate for a 30-year fixed mortgage climbed above 6 percent last week from a four-year low of 5.48 percent four weeks earlier, (both quoted with borrower’s paying a 1% origination fee) according to Freddie Mac in McLean, Virginia. The increase added $107 to monthly payments for a $300,000 mortgage, data compiled by Bloomberg show. Over the course of a 30-year loan, it added $38,000.
Mortgage applications in the U.S. fell by the most in four years during the week ended Feb. 15 as higher rates sapped demand, the Mortgage Bankers Association in Washington reported last week.
‘Reject the Loan’ :
The group’s index of applications to buy a home and refinance a loan fell 23 percent to 822.8 in the week ended Feb. 15, the biggest drop since July 2003 when it fell 24 percent when rates climbed more than a percentage point.
About 55 percent of U.S. banks tightened underwriting standards on prime mortgages in 2007’s fourth quarter, according to the Federal Reserve Senior Loan Officer Survey, published in January. That’s up from 40 percent in the October survey. (And the credit guidelines continue to tighten weekly – so if you have any borrowers on the fence – NOW is the time for them to buy while they still qualify and if you have seller waiting, Now is the time for them to sell while the buyers are able to purchase!)
The report showed 85 percent of banks raised qualifications for so-called non-traditional loans, such as interest-only mortgages, compared with 60 percent in the October survey.
“Everyone is afraid,” said Shaughnessy of Foundation Mortgage. “The mentality is: when in doubt, reject the loan.”
Bank seizures of U.S. homes almost doubled in January as property owners failed to make higher payments on adjustable-rate mortgages, data compiled by Irvine, California-based research firm RealtyTrac Inc. show. Repossessions rose 90 percent to 45,327 last month from a year earlier, RealtyTrac said today in a statement. Total foreclosure filings, which include default and auction notices as well as bank seizures, increased 57 percent.
Home Sales:
Sales of existing U.S. homes declined in January to the lowest since records of combined condominium and single-family transactions began nine years ago, and prices slid for the sixth time in seven months, the Chicago-based National Association of Realtors reported this week.
January sales of new houses, reported tomorrow by the Commerce Department, probably fell to an annualized rate of 600,000 from 604,000 in December, according to the average estimate from 69 economists surveyed by Bloomberg.
“Unless we see a containment of inflation and more demand for mortgage bonds we won’t see lower fixed rates, no matter what Bernanke does,” Shaughnessy said.
To contact the reporter on this story: Kathleen M. Howley in Boston at kmhowley@bloomberg.net .
Last Updated: February 26, 2008 09:02 EST
Gary Gottlieb
Private Mortgage Banker
Wells Fargo Home Mortgage
3550 Round Barn Blvd Suite 307
Santa Rosa, Ca 95403
(707) 521-1239 Work
(707) 328-3586 Cell
(707) 540-6666 Fax
gary.gottlieb@wellsfargo.com - email
www.gary-gottlieb.com - web site address
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