Mortgage Market Updates

Yesterday the Fed announced that it would begin to buy mortgage and other private debt securities -- easily the most dramatic and unprecedented action in the Fed’s 95-year history.

Mortgages immediately fell a half-percent to 5.50%. An immense volume of loan-rate locks has pushed rates back up a bit today, but the decline is highly likely to resume. For the first time in the last 18-months’ credit-market nightmare the authorities have moved in front of the crisis, jumping past broken banks to fund the nation.

The Fed buys and sells short-term T-bills every day, managing monetary policy and short-term rates. However, the only prior Fed direct purchase intervention to push down long-term rates was during and shortly after WWII, and that operation was limited strictly to Treasurys. This time the Fed will buy a wide spectrum of consumer credit, driving down rates, and will eventually re-open private markets in volume.

The Fed’s actual purchases will not begin until next week, but it said it would continue to buy “over several quarters.” The Fed did not indicate any target for how far it intends to push down mortgage rates.

Why now? Two things. Last week marked the ultimate fracture in the credit markets: Treasury yields to the floor, rates for all other IOUs to the sky. No credit, no bottom for the economy. Previous efforts to cut the cost of credit (loaning cash to banks, TARP injection of capital) had not yet worked, and could not be expected to work in time. Second: the next ten days will bring awful news of economic decline in November, and the first washout of Thanksgiving shopping in modern times.

Will it work? Oh, my, yes. In 1983, the Fed entered the market in a surprise purchase of T-bills. An itty-bitty thing. A roomful of calm-to-bored pros leaped in the air, screeching, “The Fed is IN!!!” And so that roar went up yesterday. All-powerful. The Fed hasn’t spent a dime, but is already swinging a psychological hammer. The markets had priced for Great Depression II. “If the Fed is in, then we aren’t going to have GDII... If the Fed is in, what am I doing out?”

When will it work on the economy? When it does. Recessions cannot bottom without plentiful and cheap credit. Credit-sensitive industries lead the way, houses and autos; both will take a while even with credit restored. Unemployment will not crest until the recession is over. Hence, the Fed will be in for “several quarters.”

Where will the Fed get the money? If you or we print money, we go to jail. When staring at a Depression, the Fed is supposed to print money. It has infinite capacity to do so, and in this case is buying very high quality IOUs that will rise in quality as the economy heals, can be sold then, or held to maturity. The main risk is off in the future: next time we’re in a little trouble, the troubled will ask the Fed to buy again. Answer: only once every 95 years.

At your dinner table tomorrow someone will say: Hang the Fed for this! Let the market work! Inflation is certain to follow! The dollar will crash! The Fed is a giant conspiracy! Gold gold gold! Hand this individual a turkey bone and hope he chokes. No Heimlich until he admits the Depression was not cool.

How to play refinancing? Any deal that recaptures closing costs in a year or so after tax effects, do it! As always... closing costs are not deductible, interest saved is; hence savings are overstated. Calculate interest savings, not changes in payment distorted by amortization. Avoid points and origination (deductible only over the whole life of the loan!). If you have an ARM... move now.

Whose idea was this? Many of us thought it was inevitable a year ago. The idea is in Perfesser Bernanke’s book. We’re a zero on a scale of conspiracy theorists, but we have to believe that when Obama’s new team reviewed options with the exhausted group still in charge, somebody said, “What in hell are you waiting for?” If it was Hapless Hank Paulson’s work by himself... or not... hand that man some pie. It is Thanksgiving.

Economic Notes is published weekly by the Economics Department of Crestline Mortgage a division of Universal Lending Corporation as a service to Colorado Real Estate professionals. © 2008, all rights reserved.