Will The Feds Get Policy Toward Mortgage Lending Right?

The simple answer is - who knows? It's a pretty complex and derrivative answer to come up it.

I've gotten A LOT of questions over the last 7-14 days asking me what is happening to cause mortgage interest rates to change so dramatically from where we were on 1/23/08. So, I put on my best John Maynard Keynes (famed 20th century British Economist) thinking cap and would like to share the following ideas with you...with a little bit of Rich Hayden flavor!

In short, things are pretty whacked. At the moment - based on where we've moved to, I don't see the likliehood of a return to the mid-5's for conforming 30 year fixed rate mortgage for a while (possibly late spring).

The following chart shows you what has transpired over the last 3 months back into late November. We've had 2 Fed rate cuts. The biggest key about those rate cuts is that the actually cause an INCREASE in long-term rates (30 year fixed) 60%-70% of the time. Why? Because that rate-cut has an INFLATIONARY impact on the broader economy by making it cheaper to borrow money.








When people and companies can borrow more cheaply, the producers of the goods/services that those entities buy are inclined to raise the prices they charge. This is inflation. Gas, food, heat, electricity - all are in an inflationary mode right now (unless you're living under some enormous rock with your own economy). So, when inflation is an issue in the economy, long-term bonds (30 year mortgages) tend to get less "expensive" and have a higher yield (interest rate) for the purchasers of those bonds. Why? Because when the Fed Funds rate is so low, the "long-term money" has to compete for investors. To try to lure more investors to them, the bond issuers (Fannie Mae/Freddie Mac) must INCREASE the yield to make the investment profitable and attractive to the investor. We've already established that the yeild is the equivalent of the interest rate. So, you can see how this works. Fed cut = mortgage rate increase = Inflation. Inflation is a bond instruments WORST enemy. It will almost always drive the yield (interest rate) on that bond HIGHER - which, ultimately causes inflation to subside. WHAT? Yes, when things get too expensive (mortgages, cars, food, etc.) people buy less. Producers eventually have to lower their prices (see bonds above) to attract buyers - then the economy expands.

So, what you're seeing is that the Fed's activity of lowering the "Fed Funds Rate" - which is the shortest term rate on the market (the "term" on Fed Funds is 1 day, whereas your mortgage is 30 years), is having the negative impact of actually CAUSING greater inflationary pressures. Okay, that's actually pretty simple to figure out. But, we're in a bit of a Twilight Zone period economically that we haven't really seen since the mid-70's. You won't see this term in the broader media for a little bit, but, it will come about. Afterall, there is still wide-spread belief that we're not quite in a recession. Well, make no mistake about it, we're in a recession...and have been for nearly 2 months. Anyway, we have entered into a period of "Stagflation" in the economy.

This means the broader economy is suffering from inflation and stagnant economic growth (recession) at the same time. So, we combined the words in the early 70's to create "stagflation". Why this is imporant relative to our ideas about home mortgage finance and home selling is because we've got a real quandry on our hands in trying to forecast what's going to come about. What we have now vs. the 70's (oil embargo and manufacturing slow-down) is a declining housing market. We did not have that factor @ that time - at least not to the extent that we do today. So, we're into uncharted territory from an economic policy perspective and lawmakers are trying to "fix" housing - which means they are likely to hurt it as a result as most lawmakers are not economists. I don't mean that to submarine the efforts of our elected officials. Rather, it's pretty well accepted that markets are self-correcting and government intervention "typically" doesn't create economic sollitude. This is not to suggest that I am opposed to intervention.

That said, where do I think this is going? I EXPECT that long-term rates (30 year fixed) will see a bit of a rally in the spring once the most recent "fiscal stimulus package" signed by the President 2 weeks ago actually goes into effect. At that point, we should have better rates to work with. The question at that point will be what type of underwriting guideline changes will be in effect.

I hope this makes sense. It's a bit of a ramble. But, I think it's very important for EVERYONE to understand what the factors are behind this stuff so that you know it's not just some kind of "puff-here's your rate" type of idea-set. My clients are wondering if they should refinance or buy, when should they buy, how much should they buy and what they'll need to have to do it with. The answer to the question is evolving and will continue to be a fluid answer.

This information should rarely be looked upon as negative or glum. Rather, it's an analysis of data. Within that data is the power to positively impact outcomes. Historically, the greatest financial triumphs come out of the greatest failures. The key, then, is to understand the underpinnings of the system so that you can use its NEW growth to your advantage!


If you're trying to figure out what this all means to you and your financial profile - then give me a call. We will work through it together and you can get it going the way it should be so you can be an example, not a statistic.


Your Friend,

Rich Hayden
Financial Coach
rahaydenjr@yahoo.com
703.773.8409 - p

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