I can't decide what was more troublesome yesterday: the comically uninformed
questions put to Big Ben regarding mortgage rates, or the comically
inaccurate article printed by CNBC on the same subject. Whatever the
case, the media is awash with analysts, experts, officials, and laypersons offering
rather strong opinions on a subject about which they have such a painfully shallow
understanding.
Today Bernanke testified before congress on the state of the economy. I'll
leave it to the 1000 or more other articles to bring you up to speed on the
salient points. I'm more concerned with something that no one has really talked
about yet: the lack of understanding of our mortgage problems.
My concern began to peak after overcoming my amazement at a question I heard
today from Luis Gutierrez. CNBC has kindly saved me from needing to type the
exchange, listen
here.
This question would not be that troublesome at all if it came from a mortgage
consumer in the general public (if you don't know why it's troublesome yet,
that's OK, we will cover that in a moment). But it comes from a member
of the House financial services committee, a member of the subcommittee
on financial institutions/consumer credit, and the chair of the subcommittee
on domestic and international monetary policy. This guy should know something
about this topic! For all I know, he and the rest of his ilk are quite knowledgeable
in the rest of their purview, but his question, in conjunction with previous
communications from members of congress, illustrates an appalling lack of understanding
about the very specific topic of the macroeconomic role of mortgage finance.
Simply put, mortgage rates are tied to Fed policy decisions about as much as
they are tied to the price of pork bellies! OK, that's a slight exaggeration.
But I've previously written on just how unconnected the two can be. We've seen
some Fed rate cuts that have preceded decreasing mortgage rates,
and other rate cuts that have preceded increasing mortgage rates. It's enough
to confuse anyone! (sarcasm) Wait! Maybe Fed rate cuts don't have a direct bearing
on mortgage rates! (sarcasm) Sure, Home Equity Lines of Credit are tied to Prime,
but that's about it. Maybe there is more than just one thing that affects mortgage
rates! (sarcasm)
Since I know you're burning with curiosity, I'll give you a short version of
the answer Bernanke should have given. Here goes... Almost all mortgage rates
are in direct relationship with the yields of Mortgage Backed
Securities (MBS). MBS are basically bonds: when the price goes up, the yield
goes down. Their yields vary directly with mortgage rates and they are responsive
to macroeconomic forces in a similar way to other types of bonds. So since inflation
decreases today's value of a dollar, and since bonds return a fixed income,
inflation makes bonds less valuable. (do you see where I'm going with this yet?).
When something is less valuable, less people want to buy it, so the price goes
down to attract buyers. When the price goes down on a bond, the yield goes up.
And we just said that MBS yields equal mortgage rates. Ipso facto, ergo, therefore,
rising inflation is a stimulus for rising mortgage rates.
NOTE: Follow daily mortgage backed security market commentary with our blogs:
Granted, this is not the whole story, but it is one of the most easily understandable
reasons that mortgage rates have not fallen in concert with the Fed rates. Yes,
money is cheaper for banks when rates are cut but BANKS DO NOT SET MORTGAGE
RATES!!
Countrywide has to get together with Fannie Mae or Freddie Mac, pour a couple
billion dollars of 30 year fixed mortgages into a cauldron, mix well with eye
of newt and leg of toad, go down to the flea market, and auction off very small
cups of this witch's brew (individual Mortgage Backed Securities) to investors.
It's these investors: Saudi oil barons, overseas governments, institutional
investors, and billionaire Chinese businessmen, who really hold the note on
your mortgage. It's their appetites and goals that truly determine mortgage
rates. Luis Guitierrez should know that. And you should too.
The fun continued when I read CNBC's
article. I don't even have the space in this article to go line by line
on this one, but suffice it to say that, should our bovine friends (especially
bulls) not feel up to the task, the assertions herein could serve as equivalent
fertilizer.
Mortgage rates high? Historically
we're quite low! Perhaps it is referencing the fact that mortgage rates haven't
fallen as much as they "should have" considering the yield on the 10 year treasury,
which even mortgage brokers believe (incorrectly) is a good indicator of interest
rate direction.
Yes, the spreads between mortgage rates and treasury rates are wider than they've
been in the past. Maybe that has something to do with the perception of quality
decreasing in the wake of a massive mortgage crisis! (understatement) Mortgage
yields have always been higher than treasury yields in order to compensate investors
for the extra risk.
So don't be surprised when the Fed cuts rates and mortgages hold steady. As
long as inflation is a concern and the quality of MBS as an investment is in
question, there will not be a direct relationship. My Scoff-O-Meter was tripped
all the more abruptly as yesterday was a fantastic
day for mortgage rates, a very inopportune day to write such an article.
In conclusion, even if it's not feasible for the average consumer to
digest and understand the complex macroeconomic forces that govern mortgage
rates, the more people in congress and the news media that understand, the better
equipped the general population will be to mitigate our freefall towards and
stimulate our recovery from what will be one of the lowest points in our economic
history.