Treasury May Lower Mortgage Rates?

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.

1. 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.
2. How do you increase the price of mortgage backed securities? The only way that happens is by increasing the demand for them.
3. 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.
4. 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.
5. 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 up because the government is flooding the market with new debt
• Price goes down because the supply exceeds demand.
  
• Rates go up.
  

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!

Tom Vanderwell