Thursday, October 9, 2008

Dance the Night Away

There’s one web advertisement that really irritates me.  It’s that small, dancing, flash-driven woman who celebrates the fact that the Fed has cut interest rates to take mortgage rates at an all time low.  It’s a lie.

Yesterday, in a coordinated effort, the central banks of G7 countries announced a 50 basis point reduction in short term interest rates.  The largesse was another attempt to halt the financial meltdown now strangling global financial markets.  The media tells us that the borrowing of money is now cheaper.  Therefore, people assume that mortgage rates will go down, as well.

Before you call your mortgage broker for a refi, be warned.  The rate reduction will not directly affect mortgages.  The prices for fixed rate mortgages will not suddenly drop a half a point. 

No one executive possesses the power to set mortgage rates.  No grand master wakes up in a good mood and says to himself, “I think I’ll be generous today and lower 30 year fixed rates to 4%.  That should make people happy.”

Larger forces work this magic.

Banks and brokers write home loans for thousands of individuals, couples and families.  In turn, they do not for the most part keep them in their own portfolios.  They bundle them together into packages of bond-like instruments called mortgage backed securities (mbs).

Traders peddle these mbs’s back and forth in a wide electronic market.  And what investors are willing to pay for them is what determines their prices.   That’s what sets your rate.

So will yesterday’s rate cuts made by Mr. Bernanke and his international friends affect mortgage rates?  The answer is maybe, probably even.  But not directly.

Their effect will come from how they affect the general financial market mood.  Will lower yields on other bonds now make mbs’s more attractive?  If yes, more investors will want to buy them, driving their price down.  But if investors still think the U.S. housing market remains too risky, they’ll still seek other places to put their money.  Mortgage rates will not decline.

And ironically, rates could even go upwards if investors fear all the new money flooding the globe will spur inflation.  Time and markets will tell.

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