Fed Struggles To Lower Mortgage Rates

Fed Determined To Lower Mortgage Rates With Unconventional Methods

Mortgage rates started dropping late last year after the Federal Reserve announced that it would be purchasing mortgage backed securities (MBS) in an effort to lower mortgage rates.  As recently as January 13th, Fed Chairman Bernanke again attempted to talk down mortgage rates in his speech at the London School of Economics by discussing the potential purchase by the Fed of longer dated treasury securities.  Bernanke noted that “In determining whether to proceed with such purchases, the committee will focus on their potential to improve conditions in private credit markets, such as mortgage markets.”

Shortly after Bernanke’s London speech, Charles Evans, Chicago Fed Chief, reiterated the Fed’s determination to lower rates by stating that “With the United States in the midst of a serious recession, it could be useful to purchase significant quantities of longer term securities such as agency debt, agency mortgage backed securities and treasury securities.  We stand ready to grow our balance sheet even more should conditions warrant.  At the current time, the biggest concern is deflation and the Fed can worry about inflation later.”

Given the Fed’s determination to lower mortgage rates, why have mortgage rates jumped 75 basis points over the past week?

Most of the Fed’s current and potential purchases of MSB and long dated treasuries may already be substantially discounted by the market.  The larger question is does the Fed have the resources to force mortgage rates lower given the competing demands for funding by virtually every major sector of the economy? Although mortgage rates have declined , they have not dropped to the extent necessary to give homeowners truly significant savings, especially after the recent run up in rates.

The Fed views lower mortgage rates as crucial in stabilizing a collapsing housing market.  However, if the Fed could have brought mortgage rates down to 2%, they would have, which implies constraints on their ability to manage rates.  These constraints are becoming visible on the Fed’s ballooning balance sheet.  The world is discovering that there are limits on the ability of Governments to bail out every sector of the economy.  (See  Insolvent Banking System Eludes Government Containment.)

Lower mortgage rates may become a sideshow to the larger issue of the solvency of nations, with Britain being the latest example . (Gordon Brown Brings Britain To The Edge Of Bankruptcy) The demands on the British treasury to rescue the entire banking system and economy are so large that the British pound has crashed and the very solvency of Britain is now being questioned.  This unfolding financial disaster in Britain puts a serious dent in the theory that Governments have unlimited financial resources.  The implications for the US Treasury, by extension, are ominous.

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