WASHINGTON (MarketWatch) – The Treasury Department is contemplating a proposal that would cut mortgage rates for new loans for homes, according to the Wall Street Journal.
The plan would employ Fannie Mae to offer mortgages with rates as low as 4.5%, roughly 1% lower than current rates.
The measure is under consideration as part of the Treasury Department’s continued effort to limit foreclosures, which has been at the core of the financial crisis. The plan would seek to revitalize the financial market without bailing out homeowners and lenders, the Journal reported.
As part of the proposal under consideration, Treasury would buy mortgage securities backed by Fannie Mae and Freddie Mac, in addition to those guaranteed by the Federal Housing Administration.
Fannie Mae and Freddie Mac guarantee a significant chunk of all new mortgages in the United States.
Treasury may set mortgage rates at 4.5% to boost sales – MarketWatch.
Okay, not to rain on everyone’s parade, but let’s take a logical look at the numbers and the statistics behind it.
- What’s the only way possible that I’m aware of to lower mortgage rates? By raising the price of mortgage backed securities which lowers the rates on them. Lower rates on mortgage backed securities equals lower mortgage rates.
- How do you increase the price of mortgage backed securities? The only way that happens is by increasing the demand for them.
- How do you increase the demand for them? Have the government step in and buy a HUGE (I’m talking many many many zeroes!) amount of mortgage backed securities off of Fannie and Freddie.
- How is the US government going to come up with that money? All joking about printing presses aside, in reality, they are going to have to borrow the money.
- How do they borrow the money? By issuing a LOT of US Treasury bonds to finance their purchase of mortgage backed securities.
So, what happens with the price of US Treasuries if suddenly there’s another $1 Trillion on the market?
- Demand stays the same
- Supply goes way way up because the government is flooding the market with more debt.
- Price goes up down because there is more supply than demand.
- Rates go up.
(Thanks Sean for correcting my thinking on it – it was a long day yesterday!)
I was talking to another blogger this afternoon and he said it quite well. We have a supply problem. There is simply too much debt floating out there to work the way that Hank and Bernie want it to.
So far, the market has shown that they would rather earn less (frankly close to zero) and invest in US Treasuries than they would invest in mortgage backed securities. Given the history of Fannie and Freddie recently (how many billions did they lose in the 3rd quarter?) I’m not sure anyone can blame them. Can you?
So, we’ll have to see how the details pan out, but I’m not optimistic that what the plan is proposing will actually work. It might actually backfire and due to the increases in government borrowings have a reverse effect and keep mortgage rates higher.
Stay tuned, it’s going to be an interesting ride!
Brian Brady says:
This is a huge buy signal for MBS traders. Ben and Hank are trying to signal to Wall Street that the present 200bp spread is too wide.
If they reissue T-bond debt to finance MBS debt, they can play the arb game (assuming demand for Treasuries stays strong with an extra $1-2 Trillion issued.)
New originations are going to have much lower default rates than 2004-7 originations; it could work.
If Joe Strummer’s reading, my question to him is “would that be inflationary if the debt was collateralized?”
December 3, 2008 — 8:49 pm
Kevin OBrien says:
Tom,
I think the printing press joke, is unfortunately part of their plan. There seems to be very little regard, for the long term prospect of inflation, by P & B.
Since the nationalization of Fannie and Freddie they could, in a sense just offer a 4.5% note almost directly to borrowers. No matter what they try the overall effect will be to distort the market and keep it from making its correction.
December 5, 2008 — 6:34 am