Interest Rates Forecast
September 24th, 2008 by Mark FlandersThe banking system in the USA is in crisis. The Fed keeps lowering Federal interest rates, but mortgage interest rate predictions are still going up – how can this happen? And what might it mean for home owners today?
The relationship home owners need to grasp to understand interest rate predictions is the interplay between interest rates set by the Fed and mortgage interest rates charged by mortgage lenders.
Interest rates that are set by the Fed flow into the cost of funds to mortgage lenders. Banks and other lenders don’t possess all the funds they lend out when a mortgage is written – they borrow on the wholesale market 90% or more of what they lend out to home owners, at interest rates lower than the mortgage rates they charge home owners for their mortgages.
Banks make their profits from the difference between what they pay when they borrow money, and what they charge when they lend it out.
When the Federal Reserve lowers interest rates, it lowers the borrowing costs for financial institutions, so you would think that mortgage interest rate predictions would fall. However, financial institutions may choose not to pass on the savings to mortgage holders.
The reason for this is not greed – there is adequate competition in the mortgage lending market to ensure that no bank or other lender can profit unfairly. The real motivation is that being a bank that lends for mortgages just became a whole lot more risky, and risk tends to make banks raise interest rates.
Financial institutions are everyone more interest to compensate for their losses on the few who will miss payments on their mortgages.Until the current housing market settles, risks for lenders will remain elevated, and mortgage rates forecast will continue to be high.
The Fed can’t lower interest rates indefinitely. The actual interest rate (called the “nominal” rate) includes inflation. To find the “real” interest rate, you need to subtract the inflation rate from the nominal interest rate.
Today, when you do that, you get a negative number! This means that nominal interest rates are not even high enough to keep up with inflation.
Clearly, this is a situation that cannot continue for long. Sooner or later, probably sooner, the Fed will have to raise interest rates to at least break-even levels, matching the rate of inflation. As soon as it happens, the prime interest rate rise will flow through into mortgage interest rates. The only way is up for the mortgage interest rate forecast.
Share on Facebook
No related posts.
When working with buyers hesitant to buy, I’ve recently been comparing if they buy now at 6% (or what ever rates are on that day) to if they buy in the future at 7-10%. Even if the home goes down in value further, they are still typically paying less monthly.
Thanks for the infomative post on our government banking system!
One more thing for interest rates…
Given that the .gov does not control the interest rates, and they are a slave to the market, the insane borrowing that the Bush Administration has taken on to help blunt the effects of the deflationary spiral, along with the continuance of that policy, plus the insane amount of social redistribution spending in the American Messiah Administration is going to drive the demand for borrowed money throught the roof.
Now, since the velocity of money has essentially stopped, the credit markets can not sustain any extra borrowing. Add in that China will no longer be sterilizing thier trade surplus dollars with US Treasury debt, the amount of money available to borrow will also be in rapid decline.
Summary:
Demand for government borrowing will skyrocket.
Availability of foreign dollars to borrow will drop dramatically.
Velocity of money in the credit markets has essentially stopped.
Massive demand + dramatic reductions in supply = fabulous rise in the price of money, or what the common person calls “rising interest rates.”
Since .gov debt collectors have guns, their debt is the “safest” on the globe. If their interest rate climbs, then our interest rates climb proportionately, if not disproportionately.
This is why stimulus can’t solve this problem, and it will only make it worse.
You can’t stand in a bucket and lift yourself, no matter how hard you yank.
If you want my solution to this mess, I have already penned it.
http://clearcutbainbridge.blogspot.com/2008/09/way-out-of-this-mess.html
3 points:
Stop the lying and fictional accounting
Bring down leverage
Regulate credit derivatives
Note that in this scenario, we still get a painful retracement of the various asset markets. We get them anyway.
Thanks, Devils Advocate.
I think I just learned more about how our banking systme works you post than I did 4 years in college. Now that you’ve explained it, its time for you to solve it.
If I may offer an alternate explanation…
The relationship between the FED and the banking system is often misunderstood, even by people in the industry. The actions of the FED “cutting rates” or “hiking rates” is really more clerical than designed to manipulate the prevailing interest rates.
There exists a market that banks use called “Fed Funds,” or what some call “the slosh.” This is the short-term borrowing that banks do with each other to balance their reserves and take care of the day-to-day vaguaries of the banking business. The pool is actually quite small when compared to the larger banking system.
If a bank has extra money at the end of the day, it would rather loan it out to another bank and collect some interest, and likewise if a bank is short funds, they need to borrow to keep their operation within balance. The interplay between these two forces is the Fed Funds market, where a prevailing interest rate will emerge that is dependent upon the supply/demand of that market. This interest rate is called “Effective Fed Funds” (EFF).
The Federal Reserve has a Fed Funds Target (FFT), which is where it would like to keep the EFF. This is the widely published and venerated number that the FOMC moves every 6 weeks, and most people attach some form of religious devotion to its importance.
The only thing the FFT does is tell the FED to either add funds (to bring the EFF down), or withdraw funds (to bring the EFF up) to keep the EFF as close to the FFT as is prudent, If the larger demand for credit is expanding, the banks will do more business and start to require more reserves to keep them within regulatory limits. This puts a demand on the available short-term funds, which drives the EFF upward. If the FED wants to keep the EFF at the FFT, it would have to keep adding money to the slosh. If these adds become excessive, the FED will move the FFT upward to match the prevailing EFF, and will reduce the amount of funds it has to add to the slosh.
If the economy is in decline, the demand for credit will also be in decline, and the EFF will be falling. The FED will not want to keep draining funds to keep it artificially high, so it will “cut rates” or drop the FFT.
In reality, the money that a bank gets for lending comes from the private sector in forms of deposits, and large chunks of short-term funds called “commercial paper.” At this point, you are correct in saying that a bank makes its money on the spread between what it borrows (CP) and what it lends out. If the banks are having a difficult time obtaining funds to borrow, they will have to pay more for it, which will be passed on to the borrower in the form of higher interest rates. ALSO, IF A BANK IS CONSIDERED UNTRUSTWORTHY, HOLDERS OF CP WILL EITHER WITHDRAW THEIR MONEY OR LOAN IT AT A HIGHER INTEREST RATE. This will also drive up the cost of borrowing for the retail borrower (home owner).
What we have seen in the past 10 months is a failure of the US banking system. The FED had $800+ billion in its reserves last December. It was injecting this money into the banking system at a rate that it would run dry in September 08. To my knowledge, the FED has not been replenished. The reason for this is the insolvency of the system and the fact the holders of CP can do basic accounting and have access to the financial statement of the major banks.
In reality, the FFT movements have no effect on the market, other than very short term liquidity concerns. It is the underlying macro market for credit that is driving interest rates. The FED follows. It does not “set rates.” Certain banks may attempt to borrow/lend at the target, but they are ultimately slaves to the market.
The financial debacle is gaining steam. This was largely driven by the housing bubble. The only protection is to get some gold and silver coin and TAKE POSSESSION. Protect your family, or not; the choice is yours.