The Other QEII (Hint, It's Not a Ship)
Along about this time last year, there was a lot of chatter in the news and financial channels about the end of the world. Well, okay, not necessarily the WORLD, but at least the world of mortgages. The Fed was putting a deadline on phasing out its purchases of mortgage-backed securities (MBS, the instruments lenders use to determine mortgage rates). The government was ending its $8000 tax credit. Rates were going to be 11% by spring.
You might have noticed that this didn’t happen.
Oh, most of it did. The Fed did indeed stop buying MBS. The government goosing of the purchase market did (eventually) cease. And yet, rates did not rise. Not at all. In fact, they’ve kept falling steadily all year, to levels totally unimaginable by mortals. Why? And what does it mean for the future?
The why is fairly obvious. While its true that the Fed did stop its purchasing of MBS, other entities have stepped up to fill the hole, and then some. Lenders are not finding it difficult to collateralize their loans. There is plenty of money out there in the financial system, and there has been for a while. Falling rates are reflective of a market seeking a bottom. So far, it isn’t finding one. Comparatively, MBS are a great investment right now, which tells you how deep a financial hole we’re in. But as long as the government is handing out money at below 1%, banks can plow that cash back into MBS and get 4% essentially guaranteed.
But another part of the why is QE (quantitative easing). That’s a fancy term for “the government flooding the system with money”. We’ve been trying this as a tool to restart the stalled economy for… oh…about three years now. My crystal ball tells me it isn’t working, but then I’m just a mortgage guy, not a Harvard PhD in Economics. One way to quantitatively ease, the normal way, is to reduce the Fed rate. This is the rate at which the Fed will loan money to its member banks. That rate was 5.25% as recently as August of 2007. Now it is between .25% and zero.
That makes all that money coming from the Fed very cheap, which means banks borrow a lot more if it. How much money would you borrow if the interest rate was 0%? And that recapitalizes banks, which is supposed to make them lend the money to us. But they don’t, because right now you and I are a very bad credit risk. Much safer to buy treasuries and MBS.
The solution? Apparently it is MORE quantitative easing! (QEII). Since the Fed rate is already as close to zero as it can really get, the situation is more complicated. Now the Fed has to buy the bonds directly from the banks and the treasury themselves, instead of lending the money to the banks and having them buy the bonds. This should result in lower bond yields and even lower interest rates.
Yes, I said even lower. Excited about your 5% interest rate? Well, you should be. But now 4% is coming into play. Last year this time, we’d have said that was impossible, yet here we are. Is 3% also impossible? I think so. But I’ve been warning of skyrocketing interest rates for about five years now, so I’m admitting right now I have no idea. Certainly all the pronouncements of rates going up any minute ought to be taken with a sizeable grain of salt.
Eventually, the shocks of the foreclosure mess, the subprime crisis, waning consumer purchasing power and exploding deficits will likely create a clear path for the money wizards of Washington to follow. Until then, however, consult your mortgage professional about the best way to get more of your money to stay in your bank, instead of your lender’s. From a rate standpoint, things have never been better. And we may not be done yet.
Photo Credit: Alan M Hughes Via Attribution License on Flickr.Com