President Barack Obama has promised to lower mortgage rates for
Americans, but that may be harder to achieve than it appears.
Since the start of this year, the Federal Reserve, in a bid to
lower mortgage costs, spent some $70 billion to buy up mortgage
bonds guaranteed by the federal mortgage finance giants, but
mortgage rates recently have begun to tick up again.
It's a stark reminder of how intractable the problems are that
markets face and highlights the limits of even the Fed's ability to
restore normal conditions. Even as the central bank has pledged to
buy $500 billion in mortgage bonds by June, equivalent to the
year's expected net new supply, the mortgage market is grappling
with its increasing dependence on, and the rising complications
from, the Fed's involvement in the market.
For sure, the program has been successful in lowering mortgage
rates: The 30-year fixed mortgage rate fell to as low as 4.875%
from higher than 6% in November before the program was announced.
But that rate has recently risen back to 5.34%, according to
Bankrate.com, indicating the limitations of the Fed's actions.
Analysts say the Fed's buying may not be enough to push rates
below a certain point, as other factors outside of the central
bank's control put a floor under mortgage rates - from worries
about rising supply pressuring Treasury yields higher to
uncertainty over the duration of the Fed's support. On top of that,
there is the lingering ucertainty over the future of Fannie Mae
(FNM) and Freddie Mac (FRE), both of which are scheduled to get out
of their conservatorship at the end of this year.
"The Fed is trying to keep a lot of balls in the air, and one
wonders if it's possible," said Chris Aherns, a mortgage strategist
with UBS.
The Treasury Conundrum
Typically, the 30-year mortgage rate is based on the sum of the
10-year Treasury yield, the risk premium on mortgage-backed
securities and bank fees and charges.
The Fed's intervention was targeted at lowering the risk premium
on mortgage bonds over Treasurys and using this as a tool to bring
down the total mortgage rate that homeowners pay. It has been
successful to a degree: Average premiums have shrunk by 100 basis
points to 180 basis points since the Fed announced its program late
last year.
However, the increase in supply of Treasury issuance to fund the
government's many support programs for the economy, including the
mortgage plan, has pushed up yields in Treasury markets, negating
some of the beneficial impact of the Fed's mortgage purchases.
For sure, the Fed has said it would consider buying longer-dated
Treasurys, which would send government-bond yields lower again. But
it is unclear whether the mortgage market would follow suit. The
Fed itself said last week that it would only buy Treasurys if that
move would be "particularly effective in improving conditions in
private credit markets."
Supply And Demand - Where Are The Buyers?
By entering the market, the Fed created demand for mortgage
bonds, and as rates have fallen, the number of homeowners who could
benefit from refinancing their existing mortgages has risen.
Rising refinancings, however, create new supply, and there is
much concern about who would buy these freshly minted mortgage
bonds - particularly if they carry lower yields. That could drive
mortgage rates up again.
"Buying $500 billion worth of [mortgage bonds] seems like a lot,
but it's not enough to absorb the potential supply coming into the
market from refinancing activities, which are expected to climb
even further with rates remaining at this level," said Sean Dobson,
chief executive officer of Amherst Holdings, a boutique mortgage
securities trader.
While the central bank has stated repeatedly that it would go
beyond the $500 billion amount if needed, it's not clear that it
wants to buy trillions of dollars worth of new bonds.
Traditional investors in these bonds, Asian financial firms,
money managers and foreign central banks, all backed out of buying
these securities since last summer and haven't returned, leaving
the Fed as the largest buyer.
Between The Devil And The Deep Blue Sea
There's still no clear strategy to prop up the crumbling housing
market. Some argue that lower rates alone aren't a fix, as home
affordability still remains an issue. Tighter lending standards
have reduced the mortgage sizes available to prospective
buyers.
"What that means is housing prices are going to continue to drop
until they become affordable and that supply/demand imbalance
passes," Dobson said.
Some suggest that the best option may be for the government to
create an entity through which it could offer 30-year mortgages at
preset rates of say 4% or 4.5%, as an incentive to draw in
potential homeowners.
However, the issue with such a program again is the lack of
investors.
"Not a lot of buyers are likely to want to buy 3.5%
mortgage-backed security, so the government may end up being
significant holder of these loans," said Nicholas Strand, a
mortgage strategist with Barclays Capital. "And that number could
run up to trillions of dollars."
-By Prabha Natarajan, Dow Jones Newswires, 201-938-5071;
prabha.natarajan@dowjones.com
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