Why the Fed has less influence on mortgage rates

Why the Fed has less influence on mortgage rates

In the past, when the Federal Reserve lowered the discount rate, it led to lower mortgage rates for homebuyers. It was a convenient way for the Federal Reserve to stimulate the economy during an economic slowdown. By making it easier for people to get loans, more money was pumped into the economy.

But recent cuts in the discount rate have failed to have a similar effect. In fact, the gap between mortgage rates and the discount rate is the widest it has been in 20 years. Even though the Fed cut interest rates 3 times in 2008, going from 4.25 to 2.25, if we look at mortgage rates over the same time period, we haven’t been able to see much of a change. Two explanations have been presented to explain why our current situation differs from what we have seen in the past. The first explanation is that the banks faced almost 200 billion in losses from their misplaced bets on subprime mortgages and held on to high interest rates to offset some of those losses. The other explanation is that banks still see a downside to the real estate market and are trying to limit their exposure.

Considering the mortgage industry is made up of 1,000s of people, I doubt any of the opinions are completely accurate. Also, given how short-sighted the mortgage industry was in its foolish bets on subprime mortgages during the boom, I think partly the mortgage industry is just reacting. During the boom, the mortgage industry responded by competing with each other to create increasingly outlandish credit products to allow people with bad credit to get loans to gain market share. Now that the real estate market is doing badly, the mortgage industry is spooked and reacts by restricting access to loans.

Is there light at the end of this tunnel? It’s hard to say. The latest cut by the Fed from 3 to 2.25 received a positive response from the market as interest rates fell from 6.13 to 5.87 next week. But whether this is a temporary moment or a sign that the mortgage industry is comfortable with the current spread between mortgage rates and the Fed discount rate is anyone’s guess. If the latter is the case, future rate cuts should have a more favorable effect on lowering mortgage rates. While this will not cure the current problems in the real estate market, it should help alleviate some of the problems.

One thing that seems more likely is that if the housing market continues to suffer, the Fed will continue to cut rates. Current Federal Reserve Chairman Ben Bernanke gave a speech before the subprime crisis in which he described how the Fed failed to respond strongly enough during the events that led to the Great Depression, and he seems determined not to make the same mistakes. In fact, in an unprecedented move, the Fed injected over 200 billion into the credit markets last week, clearly the Fed is committed to doing everything possible to cure the credit/mortgage crisis. If banks begin to respond to interest rate cuts, the Fed may succeed in its mission to take a stronger role in preventing an economic recession.

#Fed #influence #mortgage #rates

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