Another Federal Funds Rate Cut

What Does This Mean to the Mortgage Market and to the U.S. Consumer?

On March 18, the federal (Fed) funds rate was cut again – this time to 2.25 percent. The Fed funds rate has now been lowered a full three points from its hold at 5.25 percent from July 2006 to Sept. 2007. The Prime rate followed the Fed funds rate from 8.25 percent back in Sept 2007 to 5.25 percent following this week’s cut.
Why does the Federal Reserve continue to make cuts? Quite simply, it’s an effort to increase demand for goods and services, which strengthens the economy.

Impact on U.S. Mortgage Market
The U.S. mortgage market is unlikely to see a significant impact from the Fed rate cuts. Mortgage rates are driven by long-term Treasury yields along with factors affecting investor confidence in mortgages.
This drop will also have a minimal impact on long-term mortgage rates since the 30-year conventional fixed rate mortgage rate is more closely tied to the 10-year Treasury yield. Supply and demand for 10-year Treasury bonds drive price and therefore yield movements. Economic and financial market conditions, among other factors, drive buy (demand) and sell (supply) decisions for long-term Treasury bonds and it takes time for changes in the Fed funds rate to alter those conditions.

What drives rate changes?
Inflationary pressures in today’s market (have you been to the gas station or grocery store lately?) tend to drive 10-year Treasury yields higher, which then boost mortgage rates. Recent decline in home prices and the resulting fear of holding mortgage-related assets has further increased mortgage rates as the increase in risk perception shows up in the form of higher mortgage rates.
Second mortgages may be cheaper, but certainly not easier to come by in today’s market. A lower prime rate would normally translate to a reduced rate on second-lien (“home equity”) loans but heightened risk of this product has driven home equity rates higher for many new borrowers and has dampened the overall availability of these loans. Consumers with an outstanding second-lien mortgage will likely experience a slight drop in their loan rate that would lower their monthly payment.

How does this all affect the consumer?
The average consumer will feel the impact of the Fed rate move in the decline of savings account rates and possibly a drop in the rate on their outstanding credit card balance.
A lower rate on savings accounts simply means that consumers are earning less interest on these accounts.
Consumers with outstanding credit card balances may see a drop in their interest rate and that may lower their minimum monthly payment. Borrowing costs for consumer (non-mortgage) and business investment loans typically come down when the Fed funds rate drops, but tighter lending standards today may limit the growth of these loans. Presenting consumers with a lower cost option to borrow funds may increase lending and spending activity, which can fuel economic growth and eventually perhaps even create more jobs

Fed rate cuts and mortgage rates

So the Federal Reserve cut rates again. Many mortgage applicants are calling their mortgage representative and expecting a lower interest rate. Others who have been waiting to refinance are puzzled as to why mortgage rates have not moved lower during recent 5 Fed rate cuts. In fact mortgage rates are now higher than they were before the Fed began cutting rates by in January. This is difficult to explain to many consumers who have watched a 2.5% reduction by the Fed with no benefit in mortgage rates.

Is a Fed rate cut really good news for mortgage rates? The facts may be surprising. The Fed can only control the Discount Rate and the Fed Funds Rate. This is very different from mortgage rates. A mortgage rate can be in effect for 30-years, a rate that is set by the Fed can change from one day to another.

Another common mistake is in thinking that 30-year Treasury bonds or 10-year Treasury notes are directly pegged to mortgage rates.

Those are government securities that are backed by the full faith and credit of the U.S. government and have no direct effect on mortgage rates.

So what are mortgage rates based on? As it turns out the answer is mortgage-backed bonds known as Mortgage Backed Securities (MBS). Bonds issued by Fannie Mae and Freddie Mac (MBS) and the trading performance of those bonds will determine the direction of mortgage rates. Finding the catalyst that causes mortgage bonds to move will give you the keys to finding out what makes mortgage rates rise or fall.

We know that inflation will always be a negative for any long-term bond because it eats away at the future returns. Since the bond will pay a set amount over a long period of time, that amount will be less valuable if inflation is high. Over the past several years, one catalyst that seems to be working in the opposite direction of MBS prices is the Nasdaq and broader stock market.
As bond prices rise, interest rates fall. As bond prices fall, interest rates rise. The charts accompanying this article show the Nasdaq Composite Index and the Fannie Mae 6.5% mortgage bond tend to follow paths that are almost mirror images of each other. The consistency of this behavior is astounding.

As the Nasdaq moves higher, bond prices move lower causing interest rates to rise. As the Nasdaq declines, mortgage bonds benefit, causing mortgage rates to fall. Additionally, and unlike common opinion, Fed rate cuts have had virtually no direct effect on mortgage rates. Moreover, it appears that since Fed rate cuts act to stimulate the Nasdaq, they have a negative effect on mortgage rates.

The bottom line is that it appears mortgage rates will get better if the Nasdaq sells off and will get worse if the Nasdaq rallies. So it is not necessarily what the Fed does that affects mortgage rates, it's how the Nasdaq and broader stock market interprets the Fed's action that will ultimately influence the direction of mortgage rates. This is because money managers and mutual fund companies typically keep funds in either stocks or bonds with very little in cash. If stocks are in favor, money is pulled from bonds, causing bond prices to drop and interest rates to rise. When stocks are being sold off, the money is then parked into bonds, which improves bond prices and causes interest rates to decline.

On the chart of the Nasdaq Composite Index above, notice how the price movement higher on the Nasdaq seems to correlate to mortgage bond price deterioration (shown below) and vice versa. Once again, lower bond prices translate to higher mortgage rates and higher mortgage bond prices mean lower mortgage rates.

The chart below shows how the Fannie Mae 6.5% mortgage bond has performed during the same time period. The green circles indicate Fed rate cuts and the area circled in red shows when the Fed hiked rates.

A closer look at the 5 rate cuts by the Fed this year (see chart below) shows that mortgage bond prices deteriorated after each Fed rate cut. This means that mortgage rates rose after the Fed had cut rates while many consumers were expecting their mortgage rates to decline. Worse yet are the consumers who missed the opportunity to obtain a lower rate because they mistakenly waited for the anticipated Fed action to cut short-term rates, thinking that longer-term mortgage rates would decline as a result.

Predicting the future is tough, so nothing is written in stone. Keep an eye on the Nasdaq, and keep in mind that the best rates may be behind us. But, mortgage rates are still low and could have some quick dips so make the most of them while they last.

CMG quoted in the NYSun. 2.15.08

Mortgages Get More Costly As Fed Cuts Interest Rates
By JULIE SATOWStaff Reporter of the SunFebruary 15, 2008

Since the Federal Reserve chairman initiated a series of aggressive interest rate cuts last month, it has actually gotten more expensive for buyers to take out mortgages.

The reason is that investors are increasingly fearing inflation and are driving up the yield on the 10-year Treasury, off of which most residential mortgage rates are priced. In fact, the yield on the 10-year note topped 3.8% yesterday, a one-month high; before Chairman Ben Bernanke's surprise 0.75 -percentage-point rate cut in January, the yield was 3.4%.

Bond buyers aren't likely to be reassured anytime soon, with Mr. Bernanke testifying yesterday before the Senate Banking Committee that additional rate cuts are possible. He has already cut the target for the key federal funds rate by 2.25 percentage points since September, chopping off 1.25 percentage points, to 3%, in January alone. The Federal Open Market Committee, which is responsible for cutting rates, is next scheduled to meet March 18.

"The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks," Mr. Bernanke said. He also called the economy "sluggish," saying it was unlikely to recover until later this year, and suggested there would be more mortgage-related losses at banks.

The markets responded poorly to Mr. Bernanke's testimony, with the Dow Jones industrial average falling 175.26 points, or 1.4%, to 12,376.98 at yesterday's close. The 10-year Treasury fell for the third straight day, with the yield curve steepening as the 10-year yield reached its highest level compared with the two-year Treasury yield since July 2004.

"The bond market has the ability to see into the future, and the smart money sees inflation out there," a principal at mortgage firm Commodore Mortgage Group, Richard Bouchner, said. He said that when rates were lower, he called all of his clients suggesting they refinance their mortgages. "Most stayed on the sideline because they expected more rate cuts, but now they've missed their opportunity," he said.

Mr. Bernanke's rate cuts haven't just failed to lower mortgage rates — the Fed chairman is also spurring a new credit crunch, analysts say. The leverage loan market is nearly closed, with yields so low that they offer little incentive for lenders, while worries over defaults persist.
"With Mr. Bernanke's reiteration of his current rate-cutting path, the credit market noose continues to tighten," an equity strategist at Miller Tabak + Co., Peter Boockvar, wrote in a research note. He called the tightening of credit in the market "an unintended consequence" of the Fed's rate cuts.

In addition to a lack of leveraged loans, there is a shutdown of so-called auction rate securities. This is a more than $300 billion market where long-term municipal bonds, student loans, and corporate bonds are repackaged to create short-term paper and auctioned off to investors. Investors, however, have stopped bidding for them, and so banks have stopped providing auction support. Investors and banks are balking because the breakdown in bond insurance for these securities, as monoline insurers such as MBIA and Ambac struggle to cover their losses, as well as the low yields, provide little incentive for investors to take on the growing default risk.
An analyst at Banc of America Securities, Jeffrey Rosenberg, wrote in a research note on Wednesday that 80% of these auction rate securities auctions are failing.

"With a total size of $330 billion and roughly half of that held by individuals, a significant, albeit likely short lived liquidity crunch is again emanating out of the credit markets," he wrote.
Not everyone believes Mr. Bernanke's rate cuts are bad for the economy. "The rate cuts are definitely helping," a professor of economics at New York University, Mark Gertler, said. Mr. Gertler attributed rising yields on the 10-year Treasury note to investors predicting the economy will improve and that the Fed will eventually raise rates again. "It's going to be a sluggish period for a couple of quarters, but I have reason to believe we will be in a recovery by the end of the year."

Still, a growing number of investment banks and economists are predicting we are in a recession, and some feel that Mr. Bernanke's rate cuts are not addressing the problems.
"Unfortunately, bankers are no longer in the business of taking deposits and loaning money, but rather in securitizing loans," a professor at the University of Maryland School of Business, Peter Morici, a former chief economist at the International Trade Commission, said. "Mr. Bernanke has simply not addressed this more fundamental structural problem that frustrates his monetary policy. Lowering the fed funds rate does absolutely nothing to help clear up that issue."

E-mail to CNBC re: 100% Financing and Stated Income

Good morning:
My name is Rich Bouchner and I am a principal at Commodore Mortgage Group in Jersey City. We are licensed in 8 states, and have been in business since 2003. I enjoy your work on CNBC and just wanted to offer my two cents on what seems to be available in the mortgage market place.

As you know, many lenders that had previously played in the Alt A space (loans that are above conforming limits, stated income, ect) have either pulled out of the space (Chase, Wells Fargo) or have gone out of business all together (too many to mention!). However, 100% financing and stated income deals do exist, though they are harder to originate.

Fannie Mae is still offering no money down deals for purchases. Credit needs to be in the high 600s, and borrowers are required to buy mortgage insurance. As of last week, 30yr rates for such programs were in the mid 6s.

Stated income programs are still out there as well, but except for one lender that I know of, all of the programs for those that are not self-employed, have vanished. Citi has a stated program available for 2 family investment properties up to a 80% loan to value, as long as the borrower is not taking any cash out of the property.

Hope this helps clarify what is available these days. The market is definitely challenging. Many deals that would have gotten done 6 months ago are no longer possible, but many people who should be getting loans are still getting them. Those w/ poor credit, or few assets, will most likely need to stay on the sidelines until they become stronger candidates.
Thanks,
Rich

Richard C. Bouchner
Principal
Commodore Mortgage Group Ltd.
"The Right Loan at the Best Rate"
One Exchange Place, 9th Floor
Jersey City, NJ 07302
direct: 201.830.1801
direct: 646.825.5734
cell: 917.627.3459
toll free: 888.604.7400 ext 1801
fax: 201.434.7601
www.CommodoreMortgage.com

Fed Surprises with Deepest Cut since 1984

The Federal Reserve surprised everyone Tuesday with an emergency intersession rate cut of .75%, the deepest cut in the Fed Funds Rate since 1984. The Fed Governors are acting in direct response to recent reports that the country is on the brink of recession.
If you have credit cards, auto loans, HELOCs, or an Adjustable Rate Mortgage, the Fed's decision to cut this key interest rate is great news. For long-term mortgage rates however, this could signal the beginning of the end for the lowest 30-year home loan rate borrowers have experienced since 2005.

Let's look at the impact of a few recent Fed Funds Rate cuts and the corresponding impact to home loan rates to see what this could mean for you:



Period Fed Funds Rate Cut Impact to Home Loan Rates
January to June 2001 Down 2.25% Rose 0.10%
October to December 2001 Down 0.75% Rose 0.45%
May to August 2003 Down 0.25% Rose 0.78%

Rates are predicted to be cut again when the Federal Reserve meets at the end of this month. Many believe Tuesday's action was taken because of a dramatic downturn in the stock market, where the Dow dropped 464 points, the worst single day drop since September 11, 2001. Since the Fed's announcement, the Dow has recovered much of those losses but volatility is likely to remain a consistent theme throughout the week.

If you are waiting for long-term mortgage rates to fall further from here, don't count on it. Your best chance to lock in the lowest mortgage rates since 2005 is now. Getting your application in process will allow you to capture a rate near all time lows and, with many experts predicting home values could continue to decline, waiting could kill your chance to capture a great rate if your home doesn't appraise.

This is an unprecedented market and things are moving fast. Regardless of your current mortgage, please give me a call so that we can review your current financial situation in light of these market movements.

Call today to discuss how I may assist you. Not calling today could cost you tens of thousands of dollars in the next few years. Don't let this happen. I look forward to hearing from you. 201.830.1801.

Lehman exiting wholesale channel....

Lehman exiting from the wholesale channel is a big blow for the Alt A marketplace. They had been one of the last Alt A players standing. They had many niche products particularly for HNW borrowers. Earlier this week Chase pulled most of their ALT A products and Wells has been out of the market for some time as well. Any deal that is is not a Freddie, Fannie, FHA or very clean jumbo is not going to get done. The exiting of these lenders will make a rebound in the housing market and the economy very hard to come by....

Thoughts on Paulson

Joe:

Just felt the need to comment on one of your reports this morning where you mentioned that Secretary Paulson is contemplating offering relief to high credit borrowers who are falling behind on their mortgage payments. While I understand the philosophy behind his plan, it bothers me on two levels:

1) As a homeowner w/ strong credit and an adjustable rate mortgage on my 2nd home in CT, I recently paid a lender $2,000 to obtain a new 10yr interest only ARM ay 5.5%. My old loan was a 5yr balloon at 3.75%. If Paulson’s plan in enacted, I feel as though I am being penalized for paying my debts on time and not defaulting on my obligations.

2) As the owner of a mortgage brokerage, a large part of my business plan for 2008 focused on capturing the refi opportunity being offered by the billions in dollars of ARMs that are due to adjust. The mortgage arena is tough enough as it is…never mind that the Federal government is now contemplating bailing out mortgagors who had no complaints when they were able to purchase their dream home or take cash out to consolidate their debts. Why not loosen Fannie and Freddie guidelines to allow these high credit folks to refi? This would at least assure that the investors who purchased the original paper receive the duration that they have built into their portfolio models as well create revenue for the mortgage related firms that still manage to exist outside of the NYC real estate marketplace. Maybe not a PC solution, but more in line of what I had hoped for from an ex-Wall Streeter.

I feel badly for those that are currently struggling, but the government needs to steer clear of solutions that create moral hazard for borrowers. Owning a home is, believe it or not, a privilege, not a right.

Best,
Rich Bouchner