Bailout Fallout: Higher Mortgage Rates?

by Alex Stenback on September 23, 2008

No, it is not your imagination.  Rates are on the move again, and the direction has been up, rather than down.

Since it has become clear that the ongoing cascade of bailouts will culminate in the mother of all bailouts (currently being hammered out in Congress) mortgage rates have jumped by over .5%.

There’s actually a pretty straightforward reason for this.  The bailout, in whatever form it eventually comes to pass, will require a massive outlay of funds – somewhere between 700 Million – 1.3 Trillion dollars. And much of it will be financed by an increase in government borrowing.  For sure.

And therein lies the rub, and the reason, for the recent rise in mortgage rates. 

In borrowing more, the government is (in effect) expanding the money supply; either by literally putting more dollars in circulation, or by creating a perception in world markets that they will, or will have to, in order to repay the debt.

And expanding the supply of dollars is inflationary – More dollars floating around means the dollars the Federal government uses to pay back these debts will be worth less (For evidence of this in action: Just yesterday the dollar recorded its largest ever one day drop.)

Accordingly, the buyers of this debt will demand a higher rate of return to compensate for a less valuable currency.

And this flows through to the mortgage markets, as investors, concerned they also may be repaid in less valuable dollars, demand higher interest rates.

In other words, investors in mortgage-backed investments are saying to the market: "If you might be paying me back in dollars that are worth less, we want more of them."

And so rates rise as a result.  Not lost on us is the irony in the fact that any government solution to the financial systems (ahem) issues may push mortgage rates higher, not lower.

{ 1 comment… read it below or add one }

Ryan Evans September 25, 2008 at 9:34 pm

Nice post! I appreciate it, your market watch is commendable, rates are really on the move!

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