Will Surprise Fed Move Hold the Line on Rates?

On March 18th, The Federal Reserve announced their intentions to buy an additional $750 billion of Mortgage Backed Securities (MBS) as part of an ongoing plan that began late last year.   In the first 24 hours following the announcement, the Fannie Mae and Freddie Mac 30 year fixed rates dropped a quarter point to historic levels.   Concurrent to that announcement, the Fed will also purchase $300 billion in Treasury Bills, Notes, and Bonds to promote lower lending rates for credit lines, installment loans, and the like.   Besides lower rates in other instruments, buying Treasuries has the effect of maintaining the attractiveness of the MBS market yields which compete directly with Treasuries as an investment.   The MBS market is enormous compared to the Treasury market.

Recently, several major banks have declared profits after many months of dismal reports.   Not surprising.   You may recall I recently mentioned the banks were inundated with refinances to capacity after a major rate drop in December, thus they acted in their own self interest and raised rates to curb demand for mortgages.   The major banks fired tens of thousands of employees last year.   Without the support staff available to get these loans through the pipeline, the banks found themselves swamped with business they could not handle.   Premiums on every loan went up as end investors in these loans demanded greater profit on every origination.   Hiring staff to meet demand is expensive and time consuming.   Working to production capacity at increased margin is highly profitable.   Therefore, some banks are reporting they are making money again.

These unprecedented moves by the Fed should have a tsunami effect on interest rates, but as history has shown, greed will prevail and the net effect will be slightly lower rates at maximum return for the big time players with money to lend.   After all, those with the gold make the rules.   But gold is not how the Fed pays for MBSs.   The U.S. Treasury prints new money, an inflationary move.   As the supply of money increases, so does the rate of inflation.   Rates this low cannot last forever and commodities such as crude oil and gold have soared with the expectation of inflation.

Home purchases in the next few months will be the key factor whether or not rates will continue to drop to new record levels.   The dramatic drop in rates over the last several months did not send everybody to the closing table.   New loan originations were mostly customers refinancing out of ARMs and higher rate mortgages.   This alone kept rates from sliding lower.   When the demand for homes begins to rise again, it will certainly put the banks in a position to raise rates and the trend will reverse itself.   Simple supply and demand dictates this.   Waiting to buy a home strictly on the cost of money (interest) is not a wise strategy.

This Federal Reserve motion to buy down rates is reason to refinance if you have not already done so this year.   Any rate below 7% is a low, low rate anytime in history.    The Fed is purchasing MBSs with coupons mostly above 5.5% which means they expect to recoup their money as the masses get out of notes with rates higher than 5.5%.   Yes, they want to push rates slightly lower but they also want the U.S. Treasury™s money back as soon as possible!   They want you to reduce your mortgage payment, or get the moving van ready to go!   It™s high time to get motivated.

© 2009 Michael S. Amers

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