Why Mortgage Rates are not as Low as They ‘Should’ Be

by Alex Stenback on November 14, 2008

Freddie vs treasuries wsj The Wall Street Journal yesterday addressed the fact that mortgage rates have not fallen - as many expected – after Fannie and Freddie were forced into government conservatorship earlier this year. FTA:

…mortgage rates aren't declining as they should, even as interest rates fall.

Now, we all know that mortgage rates are fickle critters.  Especially this year, where we've seen rates change almost by the hour.  All you have to do is scroll through our rate-focused twitter feed to see this in action.

But the idea that rates should be lower is an odd one.  As faithful readers will know, Mortgage rates are market based. They are not "set" by anyone, so they are always, by definition, exactly where they should be.

What the article is getting at is this:  

At the time they were placed into conservatorship, many (this writer included) assumed that something equivalent to a "full faith and credit" guarantee of Fannie and Freddie by the Federal government was part of the bargian.

But once the dust had settled, investors quickly divined that the conservatorship did NOT mean a full faith and credit guarantee, and that investment in Fannie and Freddie debt was not a "risk free" endeavor.

You can see this illustrated in the graphic. The spread between Treasury and Agency paper narrowed, but is still wider than it would be if the government were fully behind Fannie and Freddie.

[Quick Aside: If you find the concept of spreads confusing, it helps to think of this spread as a "risk barometer" for Fannie/Freddie.  Treasury notes represent a "risk free" investment, since they are backed by Uncle Sam, so they form the baseline/x-axis.

So what gives?  Simply put, investors want a guarantee, and Treasury has given little more than a handshake-and-a-wink.  Again from the WSJ:

Mr. Paulson says they now "operate on a stable footing." He added that "investors can bank on" the government's pledge to keep Fannie and Freddie from defaulting…Yet Mr. Paulson and the Treasury have proved unwilling to take further steps to address debt investors' concerns [and offer an explicit guarantee.]

Combine the Treasury's reticence with a still-imploding housing market, and it's easy to understand why real estate related debt is being shunned by many investors, and why mortgage rates are higher than they should, or could be.

But here's the other thing. All of this handwringing over interest rate levels is mostly a waste of time. 

Lets be clear.  Even if we establish that 30 year fixed rates should be at 5%, rather than, say, 5.75%, that's only a difference of $93.00 per month on a $200,000 loan.

That sort of savings won't make any but a marginal difference in demand for real estate.

So let's not pin too much hope in the lower-rates-as-the-salvation-of-the-real-estate-market, okay?

{ 1 comment… read it below or add one }

Aaron Dickinson - Edina Realty November 19, 2008 at 11:06 am

While $93/mo is a fairly marginal amount on $200,000 the psychology of a rate at 5% is worth more than the savings in my opinion. We’ll see what happens in the following months.

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