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April 1, 2010

Fed bows out -- what now for mortgage rates?

The Federal Reserve has gobbled up $1.25 trillion in mortgage-backed securities in an effort to keep mortgage rates down, but it's said repeatedly that it would stop by the end of March. Today is April 1, which means -- no fooling -- that the mega purchases are over.

Hello, higher interest rates?

Maybe not, says Reuters. At least not right away. What one arm of the government taketh away, the other giveth back.

Fannie Mae and Freddie Mac, the mortgage financiers operating under federal conservatorship, will be buying out $200 billion in delinquent loans, putting "about $140 billion of cash into private investors' hands" for reinvestment into the market.

But Mark Zandi, chief economist at Moody's, does expect that rates will go from the current 5 percent or so to over 5.5 percent by the end of the year. 

Rates matter because they play a significant role in how much house buyers can afford -- and how much sellers can get. Low-low rates help increase home prices (i.e. the aughts housing boom), or at least remove a reason for them to fall faster.

Where do you see mortgage rates going?

Are you anxiously rate-watching because you're hoping to buy (or sell) soon?

And when do you think the government will actually scale back its involvement in the housing market?

Posted by Jamie Smith Hopkins at 7:00 AM | | Comments (14)
Categories: Mortgage rates, Mortgages


As your article pointed out the FED has a method to backdoor the purchases of Mortgage Backed Securities (MBS) through GSAs. During 2009 and the first quarter of 2010 the FED was the main purchaser of the entire MBS market accumulating the $1.250 Trillion in current holding.

Given improved balance sheets over the last 15 months by private MBS investors plus the increased quality of current underwriting standard, AAA now means AAA, private investors will pick up the pace of their MBS purchases.

That being said mortgage interest rates are going to rise and may do so quickly, like .50% to 1% in a matter of a weeks.

Here are my reasons without all of the details. Normal spread between MBS and 10Yr Treasury is 1.50%, current yield on 10Yr Treasury 3.83%. That puts the fixed rate mortgage at 5.375% instead the fixed rate is setting around 5.00%, potential for immediate increase. The FED continues to go the world markets to sell debt to finance the huge deficit being created by Congress. More debt, higher risk equals higher yields demanded by world investors. Higher yield on 10YR Treasury plus above spread pushes mortgage rates higher.

My final point is the FED doesn't want to hold the current low yielding MBS in a rising interest rate market, they will start to sell this position of $1.250 Trillion. The bond market will react to this selling.

I believe fixed rates are heading to the 5.50% to 6.00% fixed rate range maybe in a blink of an eye.

If tomorrows 8:30AM Employment numbers come in much better than expected you will start to see this volatility. Remember this report is always the 800LB gorilla in the room.

I predict mortgage rates will go up to 6.0% to 6.5% by the end of the year. The spread before the Fed stepped in was about 3.0%. The typical spread in the past may have been 1.5%, but today's market is not the same as it was before. Investors will demand a spread somewhere in the middle at a minimum. The $140 billion is a drop in the bucket and won't have a lasting impact on rates. Two or three years out I would expect rates to go up to around 7.5%.

Hey Jamie,

While we agree with TC that there will be some disturbance in rates now that the Fed is out of the picture, we're of the opinion that rates won't jump "in a blink of an eye," and not by as much as TC says.

When we wrote our Two-Month Forecast for Mortgage Rates at the beginning of the month, our stance was this:

"Way back in December, we considered the entirety of 2010 as a whole, and especially the delayed end of the Fed's MBS program. At that time, we thought planning for a half-point rise in conforming 30-year fixed rate mortgages might be a prudent stance. In light of Fannie and Freddie more active role in the mortgage market, we think that there will be less disturbance in rates than that. The shift from a guaranteed public influence in the MBS market to one more dominated by private interests will bring some uncertainty, and that uncertainty -- risk -- will influence interest rates to at least some degree.

If everything works as planned [ha but does it ever?], we think that the next nine-week period [up until May] will see HSH's overall FRMI trend between an average rate of 5.25% to perhaps 5.60%. At the same time, the overall 5/1 ARM will likely wander from perhaps 5.25% to 5.60%. Although we don't usually provide an outlook for conforming 30-year fixed rates by themselves, we'll wing it a little this time, and call for a 5% to 5.40% range over the next couple of months."

Thanks Jamie, good stuff as always,

Thanks, all, for your mortgage-rate predictions. Keep 'em coming.

The significance of what the Fed was doing is that it amounted to debt monetization, or paying your bills with a Xerox machine. In light of the Fed's penchant for creativity, I postulated a while back that the same basic function could continue after the official cut off. Essentially the Fed can uphold the letter of their promise, but break the spirit of their promise. How?

Fannie/Freddie is backed by Treasury and Treasury still has the support of the Fed's Xerox machine. Ultimately the Fed can still debt monetize mortgages but pass it through Treasury as an intermediary. Bottom, bottom line, rates don't move much, but its due to more smoke and mirrors, central planning tricks, not fundamental market forces. Absent trickery and manipulation we'd quickly be north of 6.5%, about where we were before the trickery began.

Tim, you make some excellent points in your posting. This is one of those times I hope I'm wrong.

However as your stated, nothing ever seems to go as planned in the world of securities trading.

My experience with mortgage interest rates has led me to this quote, "Rates go up like a rocket and fall like a feather". ie my comment "in a blink of the eye". Check your charts over the last several years, you’ll see my point. :-)

As I said before I hope I’m wrong about such a rapid increase in interest rates. This housing market has several more years to heal and higher mortgage rates won't help although when I started lending rates were 12% with 3 points and we were busy.

Just as a point reference for potential mortgage borrowers reading this post a 1.0% increase in rate for each $100,000 equals a $ 68 increase to a monthly mortgage payment, $200,000 equals $136, so on so forth. The point being is not a deal breaker but it's an increased monthly cost resulting in a higher income to qualify for the loan.

Let us all hope for the best and plan for the worst.


Thanks for the kind words.

"Rates go up like a rocket and fall like a feather": so true.

I think we're all hoping for a subdued next couple of months (at least). I just feel as though conditions weren't good (for lack of a better word) enough for more potential buyers to take advantage of these historically-low rates -- high unemployment, tight credit conditions, etc. Yet again, I guess that's part of the reason why rates were so low to begin with...

Great dialogue,

Some rise in mortgage rates is almost expected in order to draw investors into the market, the question is how much?

Am I mis-reading the Reuters article or is this essentially a balance sheet re-shuffling to continue the same buying program?

While the Federal Reserve was engaged in this buying program since Jan 09, they were buying the actual Mortgage-Backed Securities in question from...Fannie, Freddie and Ginnie Mae, right?

And now Fannie and Freddie will be picking up the slack and...buying their own assets? What is the actual transaction here and who are the parties?

Justin, here's another article that goes into more detail about the buyouts:

I agree with posts above that state that the housing market needs to heal.

The question is - what is the definition of a "healed market"?

For me, it is quite simple: Prices that correlate with income and creditworthiness. On that note, I think mortgage rates that "go up like a rocket" , lets say to 10% for a 30 year fixed, would be of great benefit is allowing this very very injured market to truly heal.

Thanks to Justin for calling the emperor has no clothes. There appears to be no functional change given that Fannie/Freddie have the unlimited backing of Treasury and Treasury has the unlimited backing of the only legally authorized Xerox Machine, the Fed.

We will know for sure if we see a spike in how much the Treasury is looking to borrow through its Treasury auctions in the coming months.

Darwin Rules, you asked a great question, "what is a healed market".

I think for those of us in Real Estate a healthy housing market means many things.

My opinion is we see home appreciation at or above annual inflation rate, foreclosures go back to the normal levels between 2.5% to 3.5%, homeowners can afford to pay the mortgage, taxes and insurance while maintaining and improving their property.

On the home financing side we fully document the borrower’s ability to purchase. There are only three areas of concern with a mortgage lender, ability to pay (income and sources of funds to purchase), willingness to pay (credit report) and appraised value (independent appraiser). This is not rocket science.

If a lender does the above tasks, which they are doing now, the world's Mortgage Backed Securities (MBS) investors know the Triple A rating on their MBS is really Triple A. Many of these MBS investors found out in 2007 to present the Triple A (AAA) rating on their MBS was really a junk MBS. We destroyed confidence and created enormous financial hardship.

Too many individuals were allowed to purchase homes with little or no verification of income or cash at inflated home prices. Not only have they lost their home the other homes in their community have also been decreased in value.

I believe the last number I saw was about $8 Trillion ($8,000,000,000,000.00) of value has been taken out of Real Estate market. There is more to come with the expectation that foreclosures will not PEAK until mid 2011.

The new mortgage reforms will make it hard for prospective homeowners to get a home loan, even with lower rates. Many will not be able to meet the stringent income to mortgage payment ratio of 28% and heftier down payments and as a result we will see more renters.

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About Jamie Smith Hopkins
Jamie Smith Hopkins, a Baltimore Sun reporter since 1999, writes about the regional economy. Her reporting on the housing market has won national and local awards. Hopkins is a Columbia native and has lived in Maryland all her life, save for 10 months spent covering schools in Ames, Iowa.
She trained to become a wonk by spending large chunks of time as a geek and an insufferable know-it-all.
Baltimore Sun articles by Jamie

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