How come mortgage interest rates rise when the Fed cuts the short term rates?

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 1 percent. Shouldn’t this lower mortgage interest rates?  Actually, no! (Official statement by the FOMC can be read from link provided at end of this post)

 

Many mortgage applicants are calling their mortgage representative and expecting a lower interest rate. Others who have been waiting to refinance are puzzled as to why mortgage rates have not moved lower during the past Fed rate cuts. This is difficult to explain to consumers who have watched the Fed Funds rate reduction by the Fed with very little benefit in mortgage rates.

 

Is a Fed rate cut really good news for mortgage rates? The facts may be surprising. The Federal Reserve can only control the Short-Term Overnight Lending Rate, the Fed Funds Rate and the Discount Rate, which have a very close relationship to the Prime Rate, fabulous news for all of you holding lines of credit tied to prime!

 

This is very different from mortgage rates.  A mortgage rate can be in effect for 30-years while a rate set by the Fed can change from one day to another.

 

The reason for this is simply a matter of cash movement. The stock market has as much of an impact, if not a greater impact, on mortgage interest rates as the Federal Reserve. Mortgage interest rates move in accordance with the trading of what is called the mortgage-backed securities. This is a secured instrument similar to that of a bond, and when people are putting money into equities (that being the stock market), the money going into stocks is typically coming out of bonds and mortgage-backed securities to fund the purchase of these stocks.

 

When the stock market is selling off, money is coming out of stocks and the money needs to have a place to be parked, in many cases a safe haven, to generate a secured guaranteed yield. That is when the money goes into bonds or mortgage-backed securities. When the money goes into bonds or mortgage-backed securities, rates on mortgages come down. When mortgage-backed securities are sold to generate cash flow to investment stocks, rates go up. The much more accurate and dynamic relationship is that between stocks and mortgage-backed securities, not the Federal Reserve.

 

In summary, the Fed lowers rates, stocks rally, mortgage-backed securities sell off and mortgage rates go up. That is the dynamic and the occurrence that we need to be very careful to watch.  We are seeing this occur today as I write this piece!  

 

Now, I have seen the exact opposite happen, on many occasions where the Fed raises interest rates. The stock market does not like high interest rates because it cuts into corporate profits. The Fed raises rates, stocks sell off and mortgage rates actually improve. Just because the Fed is expected to lower interest rates, this does not have a direct impact of any positive result on your home mortgage.

 

We at Sapphire Mortgage are experts at monitoring the markets; we watch the Mortgage-Backed Securities as a trader would watch the stock market. 

 

If you or someone you know is seeking to purchase or refinance, please feel free to contact Nancy Bayron at Sapphire Mortgage  808-242-8110

to get a game plan together on your mortgage financing needs.

FOMC official statement: http://www.federalreserve.gov/newsevents/press/monetary/20081029a.htm

Afraid of buying real estate? Let’s look at some reasons why you should…

 

In these uncertain and turbulent times it is still a wonderful investment!

• Not as speculative as investing in the stock, bond and commodity markets.
•  A piece of real estate is a real tangible asset that WILL GROW in market value over time.  Just maintain the property and keep it in good shape to maximize when you do sell. 
•  It provides leverage – you purchase the whole investment with a down payment not the entire sales price. (not so with other investments – you must pay 100% of your investment).
• Tax benefits are wonderful! For your 10-20% initial investment you get to depreciate your asset and enjoy the tax-deductibility of your mortgage interest.
• If the property is your primary residence you get to avoid capital gains. Live in your home two years and pay no capital gains up to $250,000 for singles, $500,000 for married couples.   Convert your primary after two years to a rental and you can still come out ok by renting it for three!
• Property an investment property? Consult your tax-prepayer on the myriad of write-offs you can take against your rental income.
• A home is a “home”!   This is a place you own, not renting from a landlord that has control, you have control!  Over where you live, the style of home, what you choose to improve or not improve, the color scheme, the décor!  Someplace to watch your family grow and plant roots. So what you don’t have equity today – you will one day, in the mean time you have a “home” where memories grow?

 

The Chinese have a proverb: “May you live in interesting times.”

The Chinese have a proverb:  “May you live in interesting times.”  And we are living through interesting times indeed. 

 

Whatever the political posturing regarding the current rescue plan, a plan needs to be passed. Credit markets are frozen and banks are going bust every day. This is not totally because of “toxic” mortgages. This has a lot to do with FASB 157, also known as “mark to market”.

 

Each day lenders must mark their assets to the marketplace. It’s like you having to appraise your home everyday and if your neighbor was under duress because they got very ill, divorced, lost their job and was forced to sell their home quickly they may have sold it super cheap. Now, does that mean your house is worth that super cheap price? Clearly not. Why? Because you are not under duress. You have the time to sell your home and get a more normal price, which more accurately reflects true market conditions. But “mark to market” does not allow for this, which creates a vicious cycle.

 

Why is this so bad? Because as lenders mark down their assets, the amount that they have loaned previously becomes much riskier in relation to their assets. For example, say a bank has $1 million in assets and say they have $15 million in loans outstanding. Their ratio is an acceptable 15 to 1. But should they take a paper write down of $500 thousand due to “mark to market” requirements, their ratio suddenly changes to 30 to 1. This is because their assets are now only $500 thousand after taking the paper loss, while their loans outstanding are $15 million. And at 30 to 1 this bank is viewed as a risky investment. So the stock price starts to get hit, it becomes harder to borrow, and most importantly harder to make money. The bank is then forced to sell some of its loans to reduce its ratio…at cheap prices. And this makes the vicious cycle continue.

 

And a quick look at the holdings of these loans show that 95% are problem free. Additionally, the Credit Default Swaps (CDS) that are used with the pools of mortgages are relatively safe. But this requires a bit of understanding. You see, when a pool of mortgage loans is put together, it isn’t just A paper or B paper etc….it’s everything. It’s got some A paper, B paper, C paper…and even what looks like toilet paper. An “A” investor buys the whole pool but because they are an “A” investor their safety is greater because they can avoid the first 20% (an example) of defaults. So they own the whole pool but are sheltered from the first batch of defaults, and for this they get the lowest rate of return. As you can figure from here the more risk investors want to take, the higher the return. So the investments are relatively safe, but the accounting rules currently place undue pressure on the banking institutions.

 

Now add to all this, the opportunistic “shorting” done on the financial stocks, much of it illegal because those shorts did not legitimately borrow shares (called naked shorting), and you exacerbate this whole problem. Thank goodness for the recent temporary ban on shorting in the financial sector. As for the plan the government is the only one who can step in to do this. And they have to do this. And they will do this. The nauseating political posturing from both sides is just part of the process.

 

This is not easy to understand for the general public. In fact most politicians don’t get this either. That’s why it is a difficult yet critical bill for them to vote on.

 

Once this is done it will take some time but the markets will stabilize. As for the real estate and mortgage industries, it will take a bit of time but we will make it through this.  Rates will remain attractive and the influx of credit availability will help the housing market gradually improve. This ultimately will be the medicine needed to improve the situation overall.

 

As always – please keep in touch, especially during these volatile times. I am here to help you in any way that I can.

Show of global rate cuts designed to avoid depression

You can still find xperts

MarketWatch

	More rate cuts in train, economists say Show of force designed to avoid depression By Greg Robb, MarketWatch Last Update: 10:33 AM ET 10/8/08 WASHINGTON (MarketWatch) – Economists are convinced that there will be more rate cuts in coming weeks, as global central banks seek to get the financial market functioning. “There is more to come,” said Ian Shepherdson, chief U.S. economist at High Frequency Economics. Global central banks slashed interest rates early on Wednesday in a global show of force. See full story. The goal of the coordinated action is simply to avoid a depression. Will it work? Economists say that it should, but say it is going to take time. And there are many moving parts. Rate cuts alone won’t accomplish the task. “The playbook to avoid depressions says rates need to be as close to zero as possible, banks have to be rescued, public spending has to rise and free trade must be maintained,” Shepherdson said. The central banks are “on the same page” that growth is in trouble and inflation is not a problem, said Jonathan Basile, an economist at Credit Suisse Holdings. He forecasts that the Fed will cut rates by another half point to 1% – sooner rather than later. Many economists see another rate cut at the Fed’s next formal meeting on Oct. 28-29. The Bank of England and the European Central Bank are also expected to continue to cut rates, but on their own timetable and based on their own forecasts. Howard Archer, chief UK and European economist for Global Insight, forecast the ECB could cut rates again before the end of the year. He said rates would fall to 3% from the current 3.75% rate during 2009. Archer forecast that the BOE would cut interest rates by a further quarter point in both November and December, taking rates down to 4% by the end of the year. There may be deeper cuts if the financial sector problems linger, he added. Financial markets are barely working as investors only want the safest assets, like U.S. Treasury notes and bonds or cash. It is a wise move to ease policy because policymakers want to create calm market conditions, said Mike Moran, chief economist at Daiwa Securities. “There will come a time when fear will dissipate, you want to have a friendly financial environment in place,” Moran said. Basile of Credit Suisse said one general reason for cutting rates is to make the return on cash and safe assets so low that it encourages investors to take more risk. Stephen Gallagher, economist at Societe Generale, said it was crucial that European central banks cut along with the Fed. He said the interest-rate differential between the Fed and Europe meant that Fed liquidity was being sucked overseas.

The House OKs Bail-out Plan!

The House OKs a plan to allow the U.S. to buy up to $700 billion in securities afflicting credit markets.  The bill was revamped to make it more palatable to the House of REpresentatives after the failed to pass the first go-around on September 29th.  The September rejection of a $700 billion plan cost us a mere $1 trillion as the market response was that the S&P 500 Index plunged to its worst day since the week of the 1987 stock-market crash, wiping out more than $700 billion in the index’s market value! In total, more than $1 trillion was wiped off the value of the entire U.S. stock market!

Today after the bailot passed, the markets reacted negatively as uncertainty continues on whether the bailout plan will actually help our credit markets and ultimately avoid a very bad recession.   Time will tell, this is certainly not a panacea for all that ails our troubling ecenomy but something drastic needed to be done and I for one HOPE this HELPS!! Time will tell, perhaps traders and the market movers will have time to digest the entire Bill over the weekend and we will see some improvement next week.

If you feel up to to reading the bill in its entirety (451 pages) please shoot me an email at Nancy@MauisMortgage.com and I will be happy to forward it onto you in a pdf!