Update1 What Would Mortgage Rates Be Like Without the Fed?by Tim Manni
The Fed has some important decisions to make before year’s end — like whether or not to purchase more than $1.25 trillion in mortgage-backed securities (MBS).
Today, as the Federal Open Market Committee (FOMC) begins day one of their two-day meeting, analysts are expecting that, when the FOMC meeting concludes tomorrow, the Central Bank will keep the target for the Fed funds rate between 0% and 0.25%, and that the Fed will likely phase out their MBS program by December as previously planned.
But what will happen to mortgage rates when this program comes to a close? Since the MBS purchase program began, the Fed has bought some 80% of the mortgages sold in this country, the Wall Street Journal estimates. How badly will affordability be affected if there is no longer a strategy in place to keep rates subdued?
Any reduction in Fed purchases would likely affect housing affordability. In the six months before the Fed began buying mortgages late last year, 30-year conventional mortgages yielded an average of 2.4 percentage points more than 10-year Treasury notes, a useful benchmark for such long-term loans since most mortgages get repaid before 30 years.
In the six months since the Fed expanded its purchase program in March, mortgages have yielded roughly 1.7 percentage points more than Treasuries. Thus the gap has narrowed by 0.7 percentage point. While other market influences also are at work, the Fed’s purchases are likely responsible for most of the difference.
Absent the Fed, then, the national average conventional fixed mortgage rate might be closer to 5.9% than 5.2%, its level last week, according to mortgage-data tracker HSH Associates. That would make a big difference for housing.
We may sound a bit contradictory to some readers, given that we constantly advocate for as little government interaction in the private market as possible. However, the fourth quarter of 2009 is rapidly approaching, and the many plans put into place by the Fed to resurrect sectors of our economy from recessionary levels are due to expire in 2010 or before.
The term “double-dip recession” has become a popular buzzword to describe the possibility that a quick economic recovery will be just as promptly followed by another downturn. On Sunday we wrote about the one-month boost the Cash for Clunkers program gave to auto sales: record sales increases in August followed by historic drops in September.
After this week’s FOMC meeting, the Fed has only two more on schedule before year’s end. The only hint of an exit strategy we have learned from any of the Fed’s past releases is that they plan to slowly phase out their purchases of MBS, Fannie and Freddie debt, and Treasury Securities. Yet, the resounding question from professional and consumers alike is “is our economy ready to support itself on its own?” And, according to the Journal, banks won’t be ready to take over purchasing MBS until the economy has proven it can stand on its own two feet.
Last week we celebrated, so to speak, how far the economy has come one year after it collapsed. The next few FOMC meetings will be very critical for us to monitor in order to get some sense of what we’re truly up against come December.
Update1: For more on the subject, our friend Rebecca Wilder at NewsNEconomics.com has more useful information and predictions in terms of the Fed’s exit strategy and how our future economy will respond.