Some First Thoughts On The Fed’s Bombshell

Well, I guess the Europeans now know where the Obama administration stands on stimulus. If there was any doubt, the Fed sent the message pretty clearly that it’s “damn the torpedoes …”

There is no end to the chatter about what this means for the yield curve, bank earnings, how we get out of this blah, blah, blah. If you want to cut through all of that just click over to Across the Curve. John Jansen explains in four paragraphs how they’ll play the game.

Of interest to me is the effect short and long term on the mortgage markets. So far the Fed has not been successful in bringing down mortgage rates any further than 5%. In fact rates have been trending up the last few days. Part of the reason that they haven’t come down more may be due to the fact that they’ve only purchased about $65 billion of MBS out of the $500 billion they originally said they were going to buy.

Some have speculated that lenders are holding up rates to increase profit margins which certainly isn’t out of the realm of possibility. Why they wouldn’t continue to do this should the Fed truly begin an agressive campaign to buy up MBS is a valid question. I suspect if it becomes too obvious we’ll see another Congressional grilling so the difference will probably be split.

Some suggest rates could go to 4%. That seems a bit fanciful but something on the order of 4.5% is certainly possible. Short term that has the potential to put a lot of money in homeowners’ pockets. Not a bad thing at all. It might even save a few who are on the edge.

If you would like to read some thoughts on taking this even further check out Holman Jenkins column in the WSJ today. He says just refinance everyone that’s current on their mortgage and forget about any other criteria. It is thought provoking.

Now I know that we are not supposed to think about the long term. Chairman Bernanke told us Sunday night that you don’t worry about that sort of thing when a house is on fire. But, proceeding on the pretty safe assumption that he doesn’t read this blog, let me throw out a thought.

If a significant part of the homeowner universe in the country end up with sub-five percent mortgages they are going to be held captive in their homes by those mortgages. Once rates return from Fantasy Land, and they will, the prospect of moving up in price or relocating is going to be significantly muted by those low interest rate mortgages.

The housing market has always depended on a certain amount of churn for its health. First time homebuyers build equity, see their incomes increase over time, have babies and start looking for a larger home. Those in the next tier that sell to them move to the semi-luxury end and so on and on. If the move up entails not only a bigger mortgage but a bigger mortgage at a much bigger interest rate, the churn is going to be retarded. We could see much lower sales for a long time as a result of subsidized rates.

Mobility has always been one of the great strengths of the American labor market. Pick up and move for a better opportunity. You know what’s coming. The opportunity is going to have to be pretty big to prompt a lot of people to move to much larger mortgage payments.

Just one last thing and then I’ll quit trying to throw a wet blanket on the idea. If indeed lower rates do result in a stagnant housing market it would seem that the Fed might be stuck for an awful long time with the MBS it purchases. I’m not a trader so there may be ways to unwind their ownership of which I’m not aware but it seems that they might well be long-term investors in the MBS market, not by choice but by circumstance.

OK, those are a few of the things that popped into my head. I naturally reserve the right to change my mind and when I do will reluctantly admit I was wrong.

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