North - South Korea Conflict = Lower Rates

Heightened International Tension Strengthens Dollar

The conflict between North and South Korea is having a predictable effect on credit markets this morning.

Specifically, whenever international tensions kick up, there is a flight to safety, which -- at least until now -- translates into demand for U.S. dollars and U.S. debt.

That strengthens the dollar, and (also) drives interest rates lower, however temporarily.

15 vs. 30 yr. Mortgages

Deciding Rationally -- or Realistically

I don't usually advise clients which mortgage is best for them; that depends on their financial circumstances, time horizon, credit scores, etc.

However, if clients ask, I will serve as a backstop for advice they're getting elsewhere (like from their financial advisors). And I always encourage clients to get a couple, apples-to-apples quotes for whatever mortgage they're contemplating.

So, a client called yesterday to say that he was mulling refinancing options, and that his financial advisor recommended a 30 year mortgage over the 15 year.

His chief arguments?

First, you can always make extra and/or bigger payments on a 30 year mortgage -- making it more like a 15 year.

Second, statistics suggest that if you invest the difference between the (smaller) payment on a 30 year mortgage and a (bigger) 15 year mortgage payment, you'll come out ahead.

Practical Considerations

Both valid points, to be sure.

But just like economists always used to assume -- evidence to the contrary -- that people are rational actors, how many financial advisers consider what their clients are actually likely to do?

I know my client, who doesn't like routine or regimen -- and abhors following the Wall Street roller coaster (who does, outside of Wall Street?).

Given that, the odds that he would: a) make extra payments as circumstances allowed; and b) faithfully invest the extra cash flow freed up by a 30 year mortgage, are somewhere between next-to-none and none.

The clincher was his current age: 50.

The idea of being mortgage-free by 65 was a psychologically important goal for him.

And who could argue?

Once he told me that cash flow was no issue . . . I counseled him to go for the 15 year.

P.S.: the Solomonic solution? Go for a 20 year mortgage.

Federal Reserve & Low Mortgage Rates

No Change in Mortgage Rates (Yet)

I have just received the following telegram from my generous daddy. It says, 'Dear Jack: Don't buy a single vote more than necessary. I'll be damned if I'm going to pay for a landslide.

--John F. Kennedy

Almost a month after The Federal Reserve completed its massive, $1.2 trillion purchase of mortgage securities, 30-year mortgage rates are about 5%.

What were they prior to March 31?

About 5%.

Which begs the question: did The Fed really need to spend all that money?

Post-March 31 Mortgage Rates Flat

The Dog That Didn't Bark?

So, the Federal Reserve finished its massive, $1.25 trillion purchase of mortgage securities almost three weeks ago.

Have mortgage rates spiked upwards since then?

Nope, they're basically unchanged.

What could that mean?

Other investors -- supplying fresh capital -- have taken their place (the "supply explanation"); a weak economy is keeping demand for mortgages -- and therefore rates -- low (the "demand explanation"); and/or the Fed's exit was so loudly pre-announced that the bond market already anticipated it ("other").

As they say, "buy the rumor, sell the news."

Any other "Other" plausible explanations, anyone?

Wholesale Price of Money Goes Up (A Little)

Fed Rate Bump

Today's leading financial stories are: a) the Federal Reserve's apparently surprise decision to raise interest rates on short-term bank borrowing; and b) the market's reaction to same (playing out now).

My take?

The action itself is relatively trivial: hiking rates on some arcane, overnight interest rate from .5% to .75% (yes, that's less than 1%) does not suddenly make money expensive (the same rates have been as high as 6%(!) in recent years, before "the deluge").

Clearly, then, the concern is that there are more increases to follow.

Given the hair-trigger nature of today's markets ("Explanation for Jumpy Markets"), you'd expect traders to overreact to the news -- like they now do to all news -- then settle down rather quickly.

As far as mortgage rates go, what the Federal Reserve and Treasury are doing (or not) with respect to funding Freddie Mac, Fannie Mae, FHA are much more significant than a trivial bump in banks' overnight borrowing costs.

Big Rate Drop

The Fed's "Mortgage Shopping Spree"

Drowned out in all the health care reform discussion is a quiet -- but big -- drop in mortgage rates.

As of this morning, rates on 30-year mortgages are being quoted at 5%.

That's a big improvement over just six weeks ago, when rates were in the mid-5's -- and thought to be heading higher -- based on excess liquidity-driven inflation fears.

Now, the mortgage market and long-term rates appear to be driven by two things:

One. Relatively weak demand, due to the soggy economy; and

Two. The Fed's concerted program to buy up mortgages and keep the market liquid (it has a cool, $1.25 trillion (!!) war chest to do exactly that).

Not necessarily in that order . . .

Ripple-Free Mortgage Markets

The Fed and Interest Rates

If you follow markets -- stocks, housing, you name it -- two things catch your attention: too volatile, and too calm.

The former is usually associated with rapidly changing, "macro" events that the markets are struggling to make sense of; the latter, somebody's got their "hand on the scale" (at an extreme, you get government wage and price controls).

So, how do you explain the almost ripple-free calm in the mortgage markets that last six weeks or so?

The Fed has clearly targeted a 30-year rate in the low 5's, and has been spending hundreds of billions to keep it there . .

Good News, Bad News on Interest Rates

Back to 5%?

The good news on mortgage interest rates?

After a steep climb the last two months or so, to around 5.5% on 30-year mortgages, they've now fallen back closer to 5%.

The bad news?

The reason is that the latest batch of economic news -- unemployment, economic activity, the housing market -- shows continued weakness.

China, cont.

"Geithner Says China Has Faith in U.S."
--headline, The New York Times (6/3/09)

[Editor's Note: Sorry, I'm on a China kick -- just one more in that vein. And yes, it does bear on real estate. In fact, whether China keeps buying U.S. debt -- and therefore whether mortgage rates stay low -- is probably the single biggest variable affecting U.S. housing prices right now.]

Just two thoughts on the above headline:

One. Wouldn't it be more reassuring if it read, "China says China Has Faith in U.S."??

Two. Actions speak louder than words.

Some of the most flattering things you'll ever hear about a publicly-traded company are analysts and major stockholders praising it as they seek cover to dump their shares (or recommend same). Or buy credit derivatives that appreciate as company shares tank, which is effectively the same thing.

You'd think that the Securities and Exchange Commission ("SEC) would police that (and a lot of other things), but there's plenty of evidence that they don't.

"Over a Barrel"

So here's what you're left with: don't listen to what Chinese leaders say, watch what they do.

Of late, they've been pushing to have their own currency, the renminbi, included in a basket of world currencies to serve as a meta "reserve currency." That's significant because it would supplant the U.S. dollar as the de facto world reserve currency.

Why does that matter?

A key difference between, say, Albania, and the U.S., is that the latter's debts are denominated in its own currency. If the U.S. debt becomes unmanageably large -- one of the big concerns at the moment -- it always has the option of printing more money. For now, at least.

One last quote regarding China, which already owns a trillion-plus in U.S. debt: 'if you owe your bank $1,000, they've got you over a barrel; if you owe them a couple trillion, you've got them over a barrel.'

Unfortunately, there's a crucial difference between dumping what you already have -- and buying more.

Effect(s) of Rate Jump

Didn't Lock? Wait, and Hope for the Best

Nice piece exploring the potential fallout from this week's dramatic spike in mortgage rates (Potential Consequences of 5.5% Mortgage Rates).

Although I think it's premature to entertain all the negative consequences -- after all, it's possible that rates may drop as quickly as they popped -- the post does a nice job of explaining how the mortgage market works.

In particular, if you didn't already know, lots of folks with pending re-fi(nance) and mortgage applications opt to "float" (vs. lock) their rates. So, when rates jump dramatically, these same applicants face either sharply higher borrowing costs, or, in many cases, no longer qualify for their loans. Neither is good news for the housing market, or broader economy.

On the other hand, anything that boosts anemic interest rates arguably helps millions of savers currently earning next to nothing on their liquid cash.

So what do you do if you're one of the people with a mortgage application pending, or who's contemplating refinancing?

Two thoughts: 1) the move in rates has been so huge, you'd naturally expect at least some retracement (in the stock market, it's common for a big move to be followed by a partial reversal); and 2) if your lender offers a "re-lock" option at a reasonable cost . . . get it.

Especially when rates are so volatile, getting a "second bite at the apple" is a good idea.

P.S.: the "why" of the mortgage rate spike is at least as significant as the "what." At the moment, there appear to be two, competing narratives: one camp holds that higher rates are a sign of a strengthening economy; the other, that massive federal borrowing is causing the bond market to demand higher returns. In fact, they're probably both true . . .

High-end Double Whammy

Jumbo Loan Premium to Shrink

With the collapse last year of the private mortgage bond market on Wall Street, home buyers, builders and refinancers who relied on jumbo financing were left with few sources except at punitively high interest rates and huge down payments.

--Kenneth Harney, "A Big Boost for Buyers Seeking Jumbo Loans" (The Washington Post; 3/21/09)

Ordinary economic mortals are probably not feeling much empathy for the relatively affluent these days -- especially if they have a connection to Wall Street.

However, today's housing market has delivered an unprecedented wallop to upper bracket Buyers: at the same time their wealth has been whacked -- in some cases by more than 50% -- by falling asset prices, their loan costs are at (relatively) nosebleed levels.

While "conforming" (under $417k) mortgages dropped to as low as 4 1/2% last week, so-called jumbo loans still cost 6 1/2% or more.

It's tough to be rich, huh?

Actually, that's a huge gap, and arguably, an unfair one. More to the point, closing it offers lenders some tantalizing profits.

So, as Harney is reporting in his weekly column, a number of lenders (including Bank of America and ING) are rolling out jumbo loan products that aim to slice this premium. (The impact is less in the Twin Cities than on the coasts, because home prices here are much lower.)

Interest Rates Stable

Banks Not Passing Along Rate Drop?

After a dramatic drop late Wednesday, 30-year mortgage rates have leveled off at 4 5/8% at the moment. Given the size of the Fed commitment -- up to $1 trillion in new cash aimed at mortgages -- you'd expect rates in the low 4's.

Why hasn't that happened (or at least, not yet)?

Here are the reasons being bandied about:

One. There are now many fewer lenders, so they aren't competing as hard for loans (you compete for business by offering the lowest rates).

Two. The lenders still out there are understaffed, and use interest rates as a spigot to increase or decrease loan (and refi) applications. When they're overwhelmed, like they are now, they raise rates (or don't pass along savings).

Three. Banks aren't passing along savings because they're wounded and need to replenish their capital (undoubtedly true, especially for the biggest banks).

The real explanation is probably a combination of all three of these factors; the exact mix likely varies by bank.

Ultimately, mortgages and prevailing interest rates sure seem a lot like gas prices and the price of a barrel of oil: increases show up at the "pump" immediately, while price drops reach consumers more slowly . . .

Stuck Rates

Mortgage Rates: Stuck at 5%

Local lender and blogger Alex Stenback has a nice post from yesterday, "Lower Mortgage Rates Stymied By Supply," that explains what's happening with mortgage rates right now -- and why.

Tax Credits vs. Low Rates

The Right Stimulus for Housing

There now seems to be a clear consensus that, to help the economy, government must first do something to help housing. However, there's still no consensus about what.

The two leading strategies are:

One. Using taxpayer money to basically subsidize mortgage rates down to some previously unheard of number, like 4% or even lower.

Two. Using tax incentives to motivate prospective home Buyers. There are various proposals being floated, but the basic idea is to give Buyers up to a $15,000 tax credit.

The debate isn't just over what will stimulate housing the most for the least cost, but which strategy will help housing the most long-term (or perhaps, hurt it least).

In that vein, some critics of the "cheap money" approach are concerned that that will just set up housing for another fall down the road. It's one thing to qualify for a mortgage, they point out, but completely another to be able to afford that mortgage if home prices drop and/or the economy contracts.

Lenders in Florida, Southern California, Las Vegas, Arizona and many other locales can you tell you all about that . . .

Cause(s) of Interest Rate Volatility

Interest Rate Level as Regulator Valve

Anyone in the market for a new mortgage -- or trying to refinance an existing one -- can attest to how volatile interest rates are today.

Certainly, one key ingredient is the unprecedented uncertainty in the credit markets. However, another, more recent factor is understaffed lenders.

According to local mortgage broker Alex Stenback, lenders have cut back staff to the point that they simply can't process high volumes of mortgage applications (at least not quickly).

When they're overwhelmed, they turn off the application spigot by raising rates; when they're caught up or want to attract more business, they open the spigot back up by lowering rates.

That's just one more reason for consumers to watch rates more closely than ever. Practically, that means choosing a with-it lender or mortgage broker who'll do that for you . . .

Mortgage Rate Disconnect

Dropping Mortgage Rates
Still "Artificially" High

Where should mortgage rates be right now? If historical relationships held, the rate on a 30 year mortgage would be 3.5%(!).

No, that's not a typo; going back a decade or more, long-term mortgages cost typically cost about 150 basis points more than the 10 year U.S. Treasury Bond yield. The yield on the latter now is barely over 2%.

An increasing number of commentators are joining the camp -- I've long been in it -- that closing that gap would do much to staunch the bleeding in the national housing market. In turn, stabilizing housing would do wonders for the broader economy.

In his blog post today, "Mortgage rates are still too high," economist and New York Times columnist Paul Krugman is only the latest to emphasize this link:

http://krugman.blogs.nytimes.com/2008/12/26/mortgage-rates-are-still-too-high/?hp

Lower rates have two, huge benefits: 1) they instantly increase prospective home buyers' purchasing power; and 2) they allow millions of existing homeowners to refinance, lowering their monthly payments and freeing up money for other things (like food, gas, and utility bills!).

The problem with mortgage rates, like almost everything else related to the credit markets, is that normal market mechanisms aren't working now. Instead, through its web of guarantees, bailouts, and cash infusions, the federal government is essentially deciding who can borrow, who can lend, and at what rates.

In such a command-and-control environment, the price of virtually everything credit-related could be said to be "artificial" (government-set), vs. market-determined.

If that's the case, Washington might as well "go all in" and make life easier for millions of American consumers -- not just Wall Street investment banks, too-big-to-fail insurers, automakers, etc.

Balky Buyers, Borrowers

Combating a Deflationary Mindset

One of the unintended consequences of falling prices -- for new homes, existing homes, mortgage rates, etc. -- is that would-be Buyers get out of the way, and wait for even bigger drops. There's some anecdotal evidence that that's the psychology behind many Buyers' reluctance to buy or even refinance at the moment. (Of course, a weak economy and rising unemployment have their own chilling effect.)

To pick just one example in the housing market, 30 year mortgage rates are now at 5%, the lowest they've been in more than 50 years, and significantly below the rates that prevailed during the market peak in 2006. However, many Buyers' reaction is to wait and see if rates improve even more.

On a national scale, when this "wait for better prices tomorrow" mindset takes hold, it's called deflation, and quickly becomes self-reinforcing. The need to combat this is one of the organizing principles underlying recent Fed and Treasury action(s).

At least in the housing market, there are steps you can take to mitigate the "risk" of missing out on even better prices tomorrow. For a nominal fee, many mortgage lenders offer a "re-lock" option that lets borrowers switch to a lower rate while their application is pending.