When the government nationalized mortgage lending in September, housing analysts predicted lower mortgage rates.

For a brief two-week stint, they were right — post-takeover, the 30-year, fixed rate mortgage fell below 6.000 percent nationally for the first time in 7 months.

Since then, however, mortgage markets have reversed. Rates are now at pre-takeover levels.

Now, this isn’t to say that the nationalization was a failure — far from it. The government’s takeover of Fannie Mae and Freddie Mac accomplished two very important goals:

1. It restored failing confidence in the U.S. mortgage markets
2. It opened legislative channels for faster, more relevant housing reform

And, long-term, most people agree, these are essential elements for a U.S. economic recovery. Over the short-term, however, the plan has not delivered the sustained low mortgage rate environment that was envisioned.

The biggest reason why rates are higher is because of Wall Street’s manic trading behavior. When the economic outlook shows hints of sun, investors sprint to risky stock markets; when it shows signs of gloom, they flee in favor of ultra-safe treasuries. The buy-sell patterns have led to some of the wildest trading days on record and it’s not what the Treasury expected.

See, when the takeover was first announced, mortgage-backed bonds were elevated to “government status”. This created new demand for mortgage bonds which helped to push down rates. But, in the weeks that followed, the world’s credit markets unraveled and traders sought the dual comfort of safety and liquidity in their portfolios.

That’s a combination that only U.S. treasuries can provide. Versus “true” government bonds, mortgage-backed securities are just quasi.

We can’t know where mortgage rates will move for certain but, for now at least, the 4 percent range some had predicted is out of reach. Until credit order is restored globally, expect volatility to continue and rates to remain up.

The Federal Open Market Committee voted to cut the Fed Funds Rate by one-half percent today. The benchmark rate now stands at 1.000 percent.

In its press release, the Fed wasted no time addressing the key issue at-hand, stating that economic activity has “slowed markedly”, pointing to three main causes:

1. Consumer spending is falling
2. Business equipment spending is falling
3. Slowing foreign economies are hurting U.S. businesses

Furthermore, the voting FOMC members are wary of an “intensification” of the current financial market turmoil.

The announcement’s 4th paragraph is noteworthy, too. It lists the plethora of growth-stimulating steps that the Fed has taken so far this year and concludes that credit conditions should improve in time. It does notes, however, that if markets don’t improve in good time, the committee will “act as needed”.

In the wake of the announcement, stock markets rallied. Investors liked what the Fed had to say and it drew funds into the stock market from all corners of Wall Street. Unfortunately for mortgage rate shoppers, one of those corners happened to be the mortgage bond market.

The exodus from bonds caused mortgage rates to rise.

It’s a common misconception that the Federal Reserve controls mortgage rates and today’s market action should help dispel that myth. As the Fed Funds Rate falls back near its 50-year low, mortgage rates are bumping up against a 3-year high.

Source
Parsing the Fed Statement
The Wall Street Journal Online
October 29, 2008
http://online.wsj.com/internal/mdc/info-fedparse0810.html

The Federal Open Market Committee adjourns from its scheduled 2-day meeting today at 2:15 P.M. ET and the markets are eagerly awaiting the central bank’s press release.

In it, Fed Chairman Ben Bernanke is expected to address the U.S. economy, the future of credit, and the new Fed Funds Rate.

It’s this last point to which mortgage rate shoppers should pay attention — when the Fed Funds Rate falls, mortgage rates tend to rise.

The inverse relationship between mortgage rates and the Fed Funds Rate is based on the idea that cuts to the Fed Funds Rate are designed to add gas to U.S. economic engine.

In theory, over time, Fed Funds Rate cuts work to improve Corporate America’s balance sheets, thereby rewarding shareholders. Therefore, when the Fed Funds Rate falls, or is expected to fall, investors often rush to buy stocks before their prices get bid up. Part of that process, of course, includes selling the “safe” parts of their portfolio which are usually loaded with mortgage-backed bonds.

If you were looking for a reason why mortgage rates tanked Tuesday while the Dow Jones added 11%, now you have it.

The Fed Funds Rate stands at 1.500% and markets are split about how far the FOMC will cut it this afternoon:

• A “pause” is expected by 2 percent of traders
• A 0.250% rate cut is expected by 5 percent of traders
• A 0.500% rate cut is expected by 45 percent of traders
• A 0.750% rate cut is expected by 40 percent of traders
• A 1.000% rate cut is expected by 8 percent of traders

Without a consensus opinion among traders, no matter what the Fed does today, a lot of investors will be forced to rebalance their portfolios to account for their “bad bets”. This will add to market volatility for sure.

Mortgage rates are calm this morning. The calm likely won’t last. If you are floating your mortgage rate and want to avoid additional risk, consider locking your rate prior to the FOMC press release.

Despite turmoil on Wall Street, the housing sector continues to deliver good news.

Last month, led by a 22 percent surge from the West Region, New Home Sales rose 2.7 percent over August.

A “new home” is a newly-built residence, never before lived in. New homes are usually built and sold by real estate development companies and their respective marketing firms.

The surge in New Home Sales volume is consistent with the other good news we’ve seen from the housing sector. It marks the 4th positive signal in the last two weeks.

• October 8: Homes under contract to sell surge 7.4 percent
• October 23: Foreclosed homes fall 12 percent in September
• October 24: The supply of “used homes” falls to an 8-month low
• October 27: The supply of new homes falls by 7 percent

However, it can’t be ignored why housing is showing a statistical improvement. The main causes are two-fold:

1. Banks are getting better about selling foreclosed homes
2. Builders are keen to dump their excess inventory

Both of these factors drive down home sales prices nationwide which, in turn, draws value-seeking home buyers back to the market. In addition, because the number of active sellers dwarfs the number of active buyers, today’s home seekers enjoy a tremendous amount of negotiation leverage, making real estate even more attractive.

But, as with everything in business, markets seek balance. As home supplies dwindle, buyers’ ability to negotiate sales prices and closing costs will fall. It’s Supply and Demand — as supplies drop, relative demand rises, and prices rise with it.

In every American neighborhood, homes that are priced “right” are selling quickly. And now that banks and builders have figured out the formula, more homes are going under contract than at any time since 2007.

Much of the current economic climate is being blamed on housing. If the data is accurate, though, we can infer that the climate may not last much longer.