Friday, March 20, 2009

It appears mortgage investors have been inundated with home-loan applications following the Fed's decision on Wednesday to ramp up their direct purchases of mortgage-backed securities by an additional $750 billion - bringing their total direct commitment to the mortgage market to more than $1.2 trillion dollars as part of their all-out effort to revive the housing sector.

It is probably hard for most readers to grasp the sheer size of this commitment - but maybe the following analogy will help. If you were to spend one-million dollars ($1,000,000) every calendar day until you had successfully spent $1 trillion dollars you would be engaged in this endeavor for a little more than 2,739 years.

As impressive as the size of the Fed's direct support for the mortgage market is - it pales in comparison to the $2+ trillion dollars the government will borrow before their fiscal year expires in September.

The "so what" factor here is significant. As the government moves massive amounts of supply into the credit markets - prices of government debt instruments fall - pushing up their rate-of-return to the investor. In order to compete for capital against the perceived "riskless rate of return" offered by government debt obligations - mortgage-backed securities are compelled to "sweeten the pot" by offering investors a higher rate-of-return than they can get from Uncle Sam.

In a nutshell, the Fed's decision to dramatically ramp up their direct purchases of mortgage-backed securities is designed to mitigate - for as long as possible - the upward pressure the government's gargantuan borrowing spree will put on mortgage interest rates. Even though some woefully misinformed media "talking-heads" are suggesting the Fed has become a major-player in the mortgage-backed securities market to facilitate their desire to drive mortgage interest rates to a specific level - the truth of the matter is the Fed is doing nothing more than pulling out all of the stops in an effort to delay the inevitable upward surge in the financing cost of single-family homes which is the inevitable residual of the Treasury Department's almost insatiable appetite for capital.

It would be a big surprise if 30-year fixed-rate mortgage interest rates were to move to 4.5% for any extended period of time. It is far more likely the Fed will consider their $1 trillion investment in the direct purchase of mortgage-backed securities a roaring success if, over the coming six- to nine-months, 30-year fixed-rate mortgage interest rates manage to hover between 4.75% (for borrowers with the absolute best credit rating) to a general 30-year fixed borrowing rate of 5.5% or so.

Confounding the Fed's effort to hold mortgage interest rates near recent historical lows is the fact that the mortgage industry lost significant capacity over the past 18 months. During the same period warehouse credit lines for many mortgage wholesalers were reduced and in some cases outright eliminated. These internal mortgage industry conditions are causing many borrowers to come to the realization that just because the face on their favorite financial or news network says mortgage interest rates for 30-year fixed rate mortgages should fall to 4.5% or lower -- those televised comments don't hold much water when the borrower actually moves into the market place to make loan application. The truth of the matter is wholesale mortgage lending sources may offer loans at any rate they choose - controlled only by competitive influences in the market place and the borrowers' willingness and ability to pay the offered rate.

A massive rally in the mortgage-backed securities market may make headline news - but it has no direct bearing on rate sheet pricing. The golden rule is very much the controlling influence with respect to residential mortgage finance - he/she who has the gold definitely makes the rules.

Looking ahead to the coming week Uncle Sam will be in the credit markets Tuesday through Thursday looking to borrow $98 billion in the form of 2-, 5- and 7-year notes. These auctions should be relatively well bid producing little if any ripple effect in the mortgage market - especially if central bankers choose to spend some of the $300 billion they set aside on Wednesday for the direct purchase of longer-term Treasury debt.

Next week's economic calendar will include a look at conditions in the housing sector with the release of the February Existing Home Sales figures on Monday and the February New Home Sales numbers on Wednesday. Both measures of home buying activity are expected to show a very slight improvement from the prior month's levels -- but not enough to create much of an influence on the trend trajectory of mortgage interest rates. The release of the February core Personal Consumption Expenditure Index (a component of the broader February Personal Income and Spending report) will likely show inflation at the consumer level was virtually non-existent last month. If so, this data series will likely be completely toothless with respect to its potential impact on mortgage interest rate levels.