Be careful when wishing for a Fed rate just might get it.

Mortgage and Lending with Delta Trust Mortgage

Assume that the Fed cuts the discount rate.  Will this be a good thing or a bad thing for mortgage interest rates?  Lower rates are good across the board, right?  Consumers get excited, rush out to buy a house and then call for that lower rate.  Right?  Maybe, maybe not.  You may be surprised at how the mortgage market reacts to a Fed rate cut.

Think about this.  More often than not, especially in recent years, immediate reaction to a Fed rate cut resulted in mortgage rates actually increasing instead of declining.  Why?  Because of supply and demand for investment returns. 

What do I mean by this?  I mean to say that there is a somewhat limited supply of investable funds and the equity market (stocks) and the debt market (bonds, mortgages, treasuries,etc) compete for those funds.  Generally speaking, when the stock market is having a difficult time, investors park their funds in debt and when the stock market looks like a good place to invest, those funds come flowing out of debt and back to stocks.

Over the last several weeks, the stock market has been battered and bruised over the "liquidity" issue facing mortgage makers and their backers.  Rampant selling of those stocks with even a limited exposure to the sub-prime mortgage market has resulted in an overall decline in the value of stocks.  In essence, many companies were painted with the "sub-prime" brush when they had only limited exposure.  Investors sold the stock, took their money and parked in in more secured assets-those being treasuries notes and high quality mortgage backed securities (not sub-prime).

Which brings us back to a potential Fed rate cut.  If investors have the perception that the liquidity issue has been addressed, they will sell those bonds and mortgages (even in the face of lower short termrates) and move money back to stocks.  With fixed income investments, if you have more sellers than buyers, the value of those investments decline and rates increase.  This is what COULD happen relatively soon.

Combine this scenario with inflationary pressures and you may have a very detrimental effect on mortgage rates.  This scenario is all based on investors perception about future risks in liquidity.

Again, be careful of a Fed rate might get your wish!


Comments (6)

Michael Schindler
Your IRA guy! - Galesville, WI

Sure, but a cut could also make a difference between someone making their current payments (HELOCS, and/or ARMS getting ready to adjust) or letting their house go back to the bank.  I personally think they should make it a good size cut and not mess around with little .25% movements.

The bad press has made it the norm to give a home back to a bank.  What used to be taboo is now "oh well, I'll buy again in a couple of years" around this part of the country anyway.

Good for realtors in a way because homes are moving, good for investors because more renters are coming into the market-who can pay more in rent.

Aug 30, 2007 03:38 AM
Claude Cousins
Delta Trust Mortgage - Little Rock, AR
A "good size cut" would end up being highly inflationary.  Inflation is the opposite of what this economy needs and the results of a large rate cut would create great uncertainty in the financial markets world wide.  I'm not 100% convinced a rate cut of any kind is a good idea right now.
Aug 30, 2007 10:21 AM
Michael Schindler
Your IRA guy! - Galesville, WI

What we need is for the media to stop blowing this out of proportion.  Yes, it's bad but, borrowers are starting to come into the office with the mentality of "oh well, I'll give give the house back to the bank" like it's no big deal and the media is reinforcing this thought.

I don't know if a rate cut, increase, or remain the same would matter.  I know where you are coming from, I just think the main problem is the media.




Aug 30, 2007 10:50 AM
John Popp
Charlotte, NC
A substantial rate cut of at least 1.5 to 2 % is what we need.  Both Subprime borrowers and people with HELOCS who have been hurt by their rate increasing by 3% or more need to be helped.  I do not see people running out to purchase homes anytime soon.  With Credit guidleines the way they are today it is just not going to happen.  We should not have to worry about builders increasing the purchase price because the rates are low.  At least I would hope not. 
Aug 30, 2007 11:29 AM
Claude Cousins
Delta Trust Mortgage - Little Rock, AR
It is interesting to see that the "post cut" analysis results in a market perspective that the cut was too large- thus inflationary.  The markets are reflecting this today.  History has proven that a Fed rate cut is not kind to mortgage and this lesson is probabaly going to be repeated.  Keep this lesson in mind when discussing this Fed move with potential borrowers.
Sep 20, 2007 09:49 AM
Michael Schindler
Your IRA guy! - Galesville, WI

yes, the .5% cut was a bit of a surprise.  Again, I see clients come in with the attitude of "the heck with it, my house is worth less, I might as well walk away".  and what can you do with that attitude that has been instilled into America because of the bad press?  Honestly, you sort of have to agree with them.  Most of them know that, in 2 years, we can get them another house-and there's still lenders out there that can do it a lot sooner.

it's a tough time-everyone knows this.  Cuts arent' the answer and neither is bailout.  Toughening guidelines to make it harder for people who walk away form their houses is the only way to really get through this.

Funny, people will walk away form there House no problem but, will they drop cable, cell phones (there's and their kids), curb eating out, buying or leasing new cars?  no!  We are an instant gratification society-not like it was back a few decades ago.  think anyone would be willing to buy gas only on odd days, etc.....heck no, there would be tons of law suits filed.  it's almost embarrassing seeing what our society has become.




Sep 20, 2007 10:25 AM