The Fed Struggles to Lower Mortgage Rates

Mortgage rates started dropping late last year after the Federal Reserve announced that it would be purchasing mortgage backed securities (MBS) in an effort to lower mortgage rates. As recently as January 13th, Fed Chairman Bernanke again attempted to talk down mortgage rates in his speech at the London School of Economics by discussing the potential purchase by the Fed of longer dated treasury securities. Bernanke noted that “in determining whether to proceed with such purchases, the committee will focus on their potential to improve conditions in private credit markets, such as mortgage markets.”

Shortly after Bernanke’s London speech, Charles Evans, Chicago Fed Chief, reiterated the Fed’s determination to lower rates by stating that “With the United States in the midst of a serious recession, it could be useful to purchase significant quantities of longer term securities such as agency debt, agency mortgage backed securities and treasury securities. We stand ready to grow our balance sheet even more should conditions warrant. At the current time, the biggest concern is deflation and the Fed can worry about inflation later.”

Given the Fed’s determination to lower mortgage rates, why have mortgage rates jumped 75 basis points over the past week?

Most of the Fed’s current and potential purchases of MSB and long dated treasuries may already be substantially discounted by the market. The larger question is does the Fed have the resources to force mortgage rates lower given the competing demands for funding by virtually every major sector of the economy? Although mortgage rates have declined , they have not dropped to the extent necessary to give homeowners truly significant savings, especially after the recent run up in rates.

The Fed views lower mortgage rates as crucial in stabilizing a collapsing housing market. However, if the Fed could have brought mortgage rates down to 2%, they would have, which implies constraints on their ability to manage rates. These constraints are becoming visible on the Fed’s ballooning balance sheet. The world is discovering that there are limits on the ability of Governments to bail out every sector of the economy. (See Insolvent Banking System Eludes Government Containment.)

Lower mortgage rates may become a sideshow to the larger issue of the solvency of nations, with Britain being the latest example (Gordon Brown Brings Britain To The Edge Of Bankruptcy). The demands on the British Treasury to rescue the entire banking system and economy are so large that the British pound has crashed and the very solvency of Britain is now being questioned. This unfolding financial disaster in Britain puts a serious dent in the theory that Governments have unlimited financial resources. The implications for the US Treasury, by extension, are ominous.

Stock position: None.

Comments

[wdhalgren:]

I agree with your analysis. In order to push mortgage rates significantly lower, the government would basically have to become the owner of the entire US mortgage market. From the standpoint of a realistic lender to the US, that is probably a bridge too far in terms of balance sheet expansion. At some point soon we must abandon the bailout/subsidy/stimul... mentality and let this economy deleverage, as painful as that will be. The alternative will be much worse.

Jan 23 07:08 AM

[Scott Sambucci:]

Bill - Thank you for this post.

"Although mortgage rates have declined , they have not dropped to the extent necessary to give homeowners truly significant savings, especially after the recent run up in rates." - I think this is a key takeaway that policy-markers need to understand. Dropping mortgage payments $100-$200/month for homeowners is only going to have a marginal effect on the housing market, while spurring inflation with increased market liquidity.

I'm with you on this one - seekingalpha.com/artic...

Jan 23 08:21 AM

[Alpha Econ:]

yeps, pretty much true. Although the Fed is facing double jeopardy when it comes to mortgage rates - lowering the rates, and getting the punters to take up new mortgages (rather than simply refinance existent ones). See here: trueeconomics.blogspot......
Not forgetting that pesky problem of sub-prime lending (with lower rates being an artificial incentive for lending to lower quality households).

Jan 23 08:25 AM

[kelm:]

Great post and very timely. I expect we will see rates backing up globally as the crush of sovereign debt coming to market around the world overwhelms the ability of the market to buy it all. An attendant rise in uncertainty over the solvency of nations will then result.

Jan 23 09:09 AM

[OldLimey:]

Good article.

kelm: once again, your comment is right on the mark. However, I think we're already getting there as far as uncertainty is concerned. Things are happening so quickly that we need to remind ourselves that when the year began just 23 days ago somebody questioning the solvency of the UK would have been laughed at. We know Ireland is hanging on by its fingertips. Germany has a huge problem with a banking system that has been slow to write-down assets. Spain, Greece, now Portugal....the list goes on. It is also very difficult for an outsider to have any faith in the ability of the US ever to pay down its debts, but the fact that it still prints the world's primary reserve currency will give it time to inflate away the problem (assuming the Chinese and Japanese are willing to let this happen).

One tangental issue. I assume that an aggregator/'bad bank' to warehouse the toxic waste followed by a further recapitalisation of what is then left of the banking sector is pretty much a done deal in the US. If/when that happens - and almost irrespective of whether it is destined to work as a longer-term solution - the pressure it will put on other countries to do the same will be enormous. Many simply cannot afford it. I'd be interested in comments from other folks as to whether you feel the US can go alone down this path and what will happen if it does, or whether instead some form of coordinated international approach is more likely and if so what form it might take.

Jan 23 11:16 AM

[The Mortgag...:]

The only way I see an end to this is to let the free market govern itself. No one is too big to fail, and the very idea of that is like encouraging bad behavior. The pain that will be felt by doing this is significant, but without it, we are just throwing good money after bad and digging a hole that our grandchildren will still be filling up.

The single biggest effect that government could have would be to remove the mark to market accounting rule. This rule alone can kill financial institutions (in fact, it is directly responsible for some of the recent bank collapses including IndyMac Bank), and forces them to re-value their assets on a daily basis. While this rule came about in response to the WorldComm and Enron accounting debacles, it is clearly overkill.

Jan 23 03:45 PM

[Mortgage Lo...:]

Thanks for sharing this informative article. Good info post.

Jul 28 05:04 AM