Wednesday, August 20, 2008

Fed policy has worked: Mortgage rates still low

Recently, the banking sector has suffered major losses, originating from the collapse of the subprime mortgage market. The IMF reports that banks are having problems raising capital to cover their losses, and in response, the banking sector has tightened up.

Some call it a credit crunch, the Federal Reserve is certainly indicating that loan standards are freezing up, and recently, mortgage rates are on the rise. With inflation bearing its mean face, investors are worried that the housing sector will never stabilize under the so-called credit crunch.

Some of the recent rise in mortgage rates coincides with the financial troubles of Fannie Mae and Freddie Mac; investors and banks are becoming more certain that the two mortgage giants will be forced to call upon the US Treasury for help. Since Fannie Mae and Freddie Mac “guarantee” half of the US mortgage market, banks are weary to extend loans while there is any uncertainty surrounding the health of Fannie Mae and Freddie Mac; mortgage rates rise.

Inflation has also played its part. As inflation expectations rise, banks set higher rates. With consumer prices reported to have risen 5.6% since last year.

Recently, banks have driven up mortgage rates and consumers have reduced mortgage applications. In May, the 30-year mortgage rate was 6.0%, and as of August 8, it rose to 6.5%. Contemporaneously, mortgage applications on average have fallen 3 weeks in a row. Home sales may be in jeopardy, pushing back the recovery of the housing market.
However, the Fed is on our side. In spite of record turmoil in the banking sector, mortgage rates remain at all-time lows because of the Fed’s expansionary policy that began back in September 2007. The Fed has injected enough cash into the US economy to lower short-term interest rates by 3.25%. Mortgage rates fell slightly in repose to short-term rates, and have recently risen back to their September 2007 levels, but they would be a lot higher had the Fed not stepped in.

As a counter-example, look at the UK. The UK housing market is likewise in a slump; in August, UK home values dropped 11%. The Bank of England, the British central bank, reduced short-term interest rates by just 0.25%, and that was back in April 2008. Since the Bank of England has not been accommodative, mortgage rates are on the rise. Banks have not had the luxury of an injected cash flow, and are more apt to respond to the pressures of higher expected inflation rates.

It could be a lot worse. I still expect that the US housing market will turn around soon. Sales will start to recover (2008), prices will cease to fall further (2009), and eventually, broader optimism will drive new and healthy construction (2010). Thank goodness for that dual mandate that the Fed has, and the Bank of England does not: To promote maximum sustainable growth AND stable inflation.

Please leave comments. Best, Nontruths

1 comment:

  1. Thanks for the chart! Does it occur to anyone that we are spoiled rotten these days vis-a-vis the mortgage interest rates? And, where in the constitution does it guarantee the right to own a home? We really need to get our perspective back into reality. I hope you are right about the housing market coming back sooner than later.