The Veridian Blog

A major factor to the housing market slump is inflated mortgage rates.  Although the Federal Reserve has decreased short term interest rates this year by over 3.0%, we have actually seen mortgage rates increase.  What happened? 

The liquidity crisis exploded onto the financial industry early last August and has since dramatically changed the landscape of the American economy.  In hopes of bolstering an already sagging housing sector and to stem the tide of record foreclosures, the Fed did everything in its power to make lending easier by decreasing short term rates.  Specifically, the Fed decreased the price it charges to the nation’s most creditworthy banks and the price that banks are allowed to charge each other on overnight loans.  Yet, despite decreases of over 3% in both the Discount and Fed Funds  rates, mortgage rates have actually risen in 2008.  Why?

In my view, the problem has been two-fold.  Whenever there is a loosening of the money supply, there will always be the risk of the level of prices, hence inflation, increasing to levels that will eventually hinder economic growth.  Inflation is one of, if not the most important, evils the Fed is determined to perpetually battle.  The second problem is liquidity – the namesake of this economic crisis.  No matter how bonds are traded on Wall Street and no matter how deeply discounted mortgage rates are, if there is nobody in the secondary market to purchase/invest in these loans, there is no way rates are going to fall – simple equation of supply and demand.  This, in my opinion, is the heart of the crisis.  Investors are void of trust in virtually all loan programs other than fixed rate loans and today’s mortgage rates reflect that fact. 

Until there is substantive mortgage reform, we are very unlikely to see a recovery in mortgages and housing.  There is a silver lining though for some long-timers in the industry – we knew this was bound to happen sooner or later and over the long haul, it’s absolutely better that reform happens.  For years, lending guidelines were all too lenient.  Now, they are the opposite.  With time, we will gradually find a happy medium where there is a fair dispersion of loans to borrowers who rightfully deserve them.