There has been quite an uproar about “4.5% Interest Rates” here recently. Apparently, someone suggested it in a meeting as a possibility to help the market out, the suggestion got published, and now there are many, many people starting to hold out for better rates to come.
I wanted to send an email out with my thoughts on it, and hopefully that will help all of us be better prepared when asked about it. I hope this isn’t too long or too technical, but I think it is good for you to not only have an answer for this question, but also to know they “why” behind it.
First of all, mortgages are pooled up as a securities, and sold back and forth every day. When a 6.0% bond sells for more than it’s worth, then it actually pays less than 6.0% (It pays 6.0% interest on $100, but you actually paid $102 for it, thus you are making 4% on $102, not 6.0% on $100). So, the higher the prices on Mortgage-Backed Securities, the lower the yield. The lower the yield, the lower the rate that borrowers have to pay. In order for the US Treasury to drive rates down by buying mortgage-backed securities (which is what was mentioned), the only way to do this is by simply buying up A LOT of mortgages. How much is “a lot”? Well, the federal government would have to enter into the market with such a huge amount of money that it begins to swallow up the all of the supply, causing prices to rise. And, as the prices rise, it will draw in more supply (old mortgages to be sold, or new mortgages created as refi’s or purchase), and then the demand will have to again increase to outstrip that supply.
The average trading volume of mortgage-backed securities (for January through August of 2008) is $344 Billion per day. Yes, Billion with a B. That isn’t just new mortgages, but also trading back and forth of old mortgages that are still alive. That means, for the government to affect market rates, they would have to put a TON of money into the system…possibly more money than they have put in anything else. $344 Billion per day equals a Trillion in about 3 days. And, as the interest rates/yields on mortgage backed securities go down, a lot of private money will simply leave the market place, meaning the treasury will have to increase its buying of MBS even more to not only continue to drive prices up, but also suck up the supply of the sellers that enter due to the unreasonably high prices, and also buy up enough to compensate for much of the demand from private money exiting, due to the returns being too small.
In short, to manipulate the markets in any way that has a long-lasting effect would be something so incredibly enormous, I am skeptical that it could be pulled off. If attempted, I can’t possibly see how rates could stay that low for longer than a week, simply because the supply of mortgages would sky-rocket, and the demand simply would not be there unless the government increased it’s buying even more.
There are option that is more likely is for some pool of “special mortgages” that only certain people qualify for – whether it be low-income housing, purchases in a distressed market, etc. The key here is that it would be very limited, as opening up that cheap of money to the general public would create such a flurry of activity, the money would be gone very, very quickly.
So, hopefully this helps explain the situation a little better. Right now, rates are extremely low – at their historical lows. For a customer to hold off and wait for something better is truly looking a gift horse in the mouth. But, it happens all the time…someone goes from 6.0% down to 5.5%, and they think they’ll hold out for 5.375…only for it all to shoot back up to 6.0% within a day or two!
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