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Why Aren't Mortgage Rates Dropping?

I've had a lot of questions here lately regarding mortgage rates; where they are going, why they are moving up or down, how the Fed rate cuts are affecting them, etc. It seems there is a lot of misinformation out there that we need to clear up, sooooo....... here it is; a basic economics lesson on mortgage rates!

First, let's get one thing straight. What does the Fed cutting the Federal Funds rate have to do with mortgage rates? Don't know? ALMOST NOTHING! So why do we hear so much about it? Because it's news!

Journalists have to have something to write about. That's it. CNN is on 24 hours a day. They have to fill up all of that dead air with something. Let me put this another way.... the folks covering these stories are writers! They don't know diddly-squat about the markets or economics or much about business at all unless it has to do with selling newspapers or getting the ratings up on TV. I don't know... maybe because of the the fact that I have a business degree causes me to be more acutely annoyed when I hear someone talking about the economy when they actually don't have a clue.

And just what is this "Federal Funds rate"? According to Wikipedia, "In the United States, the federal funds rate is the interest rate at which private depository institutions (mostly banks) lend balances (federal funds) at the Federal Reserve to other depository institutions, usually overnight."

Notice it says, "overnight"? How in the world can anyone assume that an interest rate on an overnight loan could be compared TO YOUR 30 YEAR FIXED RATE MORTGAGE?!?!?!

What does affect the interest rates? It is affected somewhat by indicators in the economy such as employment, manufacturing output and consumer confidence, but these are only symptoms of the true cause.... the confidence of investors who are buying mortgages. You see, banks loan money, package it and resell it to investors. This is the secondary mortgage market. Two things are affecting it right now. Foreclosures and a drop in housing values.

As of late these investors have lost their zest for mortgages. Banks are forced to sell them off "on sale" or at a discount. If you sell something at a discount to an investor, you have to charge the borrower more by way of interest rates in order to maintain profits. The long and short of it is this..... investors don't feel good about buying mortgage backed securities and insist on paying less for them, because they are riskier, I don't care how many times the Fed cuts the rate. I don't care how much money the Fed pumps into the system. Mortgage rates will not drop until investors start buying these things again.

You can thank the media for blowing this thing up beyond all meaningful or logical conclusions. It's consumer confidence baby! And it just ain't there.

Posted by Jon "J.R." Finger on 03/21/2008 12:35 PM

Comments (6)

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6 Comments on Why Aren't Mortgage Rates Dropping?

MAR

2008

You are correct for the most part, it has an affect on a 30year mortgage interest rate for about a day if you are lucky. It does have an affect on home equity lines of credit and credit card interest rates so its not all a complete waste of time. Just like the price of a barrel of oil has a small affect on the price of gas, it has more to do with demand and how much refining capacity is out there.

Hi JR,

You arn't kidding about the dead air on CNN(and others). Good thing you can't smell throught the television!

The 10 year note is the most accurate indicator of the fixe rate mortgages. The Fed can only affect this directly through open market operations, i.e buying or selling notes/bonds. The manipulation of the Fed Funds Rate can only indirectly affect the fixed rate mortgages by affecting the trading of the 10 year note. Also many lenders are still licking their wounds and are taking more margin even if the index on loan product decreases.

Yes, the word is CONFIDENCE. How confident are the investors in the mortgage backed securities.

Lowering the FEDERAL FUND RATE has no direct effect on CONFIDENCE, The ability of the consumer to continue to pay on their loans has more effect on CONFIDENCE than the Federal Fund Rate.

If I lend it to you today, will you be able to pay it back tomorrow. Will you still have a job? Will the cost of living (including the incease in ARM rate) have an effect on you ability to pay.

I for one beleive the economic stimulus package will have more of an impact on the day to lives of Americans and their ability to continue to pay, than a drop in the Federal Fund Rate.

MAR

2008

Great blog topic! I have been flooded with calls recently from consumers that are under the impression that rates have dropped or will be dropping because of the downward movement in the FED Funds rate. David is right. The 10yr note probably has the biggest impact on where interest rates will go and all the things Jon mentions in his blog are also correct.

I do enjoy the volume of calls, yet it becomes frustrating because many of these customers inquiring about refinancing are already sitting in the high 5's/low 6's on their 30yr Fixed. Exactly where the 30 has been floating around lately. This last few weeks have been pretty volatile as we have seen some nice drops, but day to day we have also been seeing some increases. Very unpredictable now.

APR

2008

Drops in the Fed Funds rate certainly do not spike MY confidence. (Every time Ben Bernanke got out of bed this spring, my European vacation got more expensive.) Is it any wonder that investors cannot get excited about debt instruments returning 5-6%, when inflation is moving toward double digits? Few recall, I guess, that by the time the US extricated itself from its last big foreign misadventure in the mid-70s, mortages rates climbed steadily up to 18%. It's a fact of life--one the Fed is desperately evading--that war sucks money out of the credit markets. But don't get me wrong. Every problem has a solution. We can make money in any market. Our first refi boom in 1982 came when the rates dropped down to 15%. . .

MAR

Great subject! I have had a lot of friends, clients, and family just have a "GLOOM and DOOM" sort of attitude. And just like JR and others have written, if the CNN news types would talk about anything else just 1/2 the time and if people would NOT take anything that they as THE GOSPEL, then it would be so much better. 24 hours of news coverage is a lot of time to fill in. There are only so many murders, politics and entertainment type stories that they can fill in those dead time spaces. And one phrase that I hate to hear is.... "in these difficult economic times....." UGGGHHH!!

I agree with what everyone else has written, the mortgage rates do not matter. If the secondary investors do not have the confidence to shop and around and actually buy these mortagees, then the only thing the to do is increase the rate of return (or in other words the interest rate). So that bank can unload the loan and have more cash on hand (so that they can loan more money). What does that mean? Of course, higher interest will mean higher inflation, and that will stink for everyone.

The only good news or promising news that I heard this week was that Citi reported a profit for Jan/Feb and even BofA said that they would not anymore money for the rest of the year. Not to mention the DOW gained the highest gain in ONE day this whole year, and then had a positive gains for the rest of the week. I thought that was awesome, and kept thinking to myself, COVER THAT one CNN!!

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