When, and how, will the Feds raise mortgage interest rates?
Last month the Feds raised “interest rates” and everyone went out of their minds. Admit it, you wondered if the end of low rates was coming, didn’t you? You were not alone.
As I explained in my post from November 30th, however, the Feds were considering moving short term rates, which don’t impact mortgage rates. How Will The Feds Affect You?
However, I also mentioned that while the Feds don’t control mortgage rates, they can and do influence them. So what, exactly, are they doing, and when will they change course? Let’s take a look.
First, we have to discuss mortgage-backed securities. Fannie Mae and Freddie Mac purchase millions of loans from mortgage lenders and banks every day. In all cases, the mortgage lenders and banks retain the servicing of the loan, meaning you still make the payments to the bank and deal with them. (Wall Street investment banks also buy pools of mortgages but for now we’re focusing on Fannie / Freddie.)
Once they buy it Fannie / Freddie now own your loan, and when the servicer collects your mortgage payment they keep a small fee for the service and send the rest to Fannie or Freddie. F/F then borrow more money by selling off bonds to institutional investors, such as pension funds, insurance funds, etc. These bonds are a promise to pay the investors using the income from the payments that you are making.
Way back when you might remember when the Feds announced QE3, an initiative to boost the U.S. economy. Part of QE3 (the third iteration of Quantitative Easing) was a plan to purchase $45 billion in mortgage-backed securities each month. Why would they do that?
Simple economics – if economics can ever be called simple – tells us that the more money that is available for borrowers, all things being equal, the cheaper interest rates go. This helped the economy in two ways.
Buying a home became a little less expensive, so demand for real estate increased and that created lots of economic activity – real estate commissions, title fees, mortgage fees, construction projects and of course, Home Depot sales to name a few.
For those who refinanced, lower monthly payments meant more discretionary cash for families to spend or save as they choose. Either way economic activity grew.
So, what kind of a difference would $45 billion a month make? To answer that, it’s good to look at two things: how much in new bonds was created during this time, and was there any difference in what the Feds were willing to pay for those bonds compared to private investors?
New issues of bonds each month varied (while the Fed’s purchase did not), but during the time the Feds were purchasing bonds the total new issues of bonds were totaling about $50 billion a month. In other words, the Feds were buying about 90% of the market, give or take. That sounds like enough to make a difference, doesn’t it?
But did the Feds pay more for the bonds than private investors would? This gets trickier. The fact that 10% of the bonds still sold to private investors shows there was some demand at the price the Feds paid for their bonds, but not a lot. Since the yield investors demand on these bonds translates directly to interest rates that you pay for your mortgage, we can compare the interest rates on mortgages written by F/F to rates of high-quality jumbo loans, since they were not purchased by F/F.
It turns out there was at least a 0.50% to 1.00% difference in interest rate between the two loan categories. This could be partly attributable to the fact that agency loans are explicitly guaranteed by the U.S. government, but the risk of failure for non-agency mortgage pools are very low right now.
So, the Feds were buying most of the market to drive interest rates down, and apparently succeeded in driving rates down by 0.50% or more. QE3 stopped in late 2013, so interest rates must have popped up after that, right? No, they didn’t.
It turns out that while the Feds stopped borrowing money from the U.S. Treasury to invest in mortgage-backed securities, they were receiving money from all those securities they already owned. (Each month they receive payments when you pay your mortgage, and if you refinance or sell your home they get all of that principal back, too.)
It turns out that the Feds have been reinvesting that money back into more MBS. In other words, they are still buying a portion of the market. How much? According to CNBC:
“In other words, all the income they receive from all that MBS they bought is going right back into buying more MBS,” wrote Matthew Graham, chief operating officer of Mortgage News Daily. “Over the past few cycles, that’s been $24-$26 billion a month — a staggering amount that accounts for nearly every newly originated MBS.”
At some point, the Fed will have to stop that and let the private market back into mortgage land, but so far that hasn’t happened. Mortgage finance reform is basically on the back-burner until we get a new president and a new Congress. As long as the Fed is the mortgage market’s sugar daddy, rates won’t move much higher.
(Read the full article here: Why the Fed Move Doesn’t Matter to Mortgage Rates)
It’s hard to find numbers on how much is sold each month, but the source quoted above tends to be fairly reliable. If so, then the Feds are quietly continuing to influence mortgage rates even though they don’t technically control them.
The Feds have announced they do not intend to curtail reinvestment of proceeds from the bonds until they have “normalized” monetary policy, meaning they are comfortable with the level of short-term rates. They have also signaled that they will probably raise short term rates four or five times in 2016. This tends to confirm what the author asserted above – mortgage finance reform is on the back burner for this year.
Isn’t that interesting?
2015 was a year of exceptional stability in mortgage rates. All indicators so far point to a repeat for 2016. Stay tuned…