Interest Rate question

cklimen · Joined: 25 Jun 2008 Posts: 3 Location: Walnut Creek, CA

In the recent past the Fed has lowered interest rates, however, it seems that mortgage rates have not followed suit, what gives?
I realize that banks have taken a pounding lately, for which I have nearly no sympathy because they all knew what they were getting into, heck, many of them were warning us of our current predicament long before we got here yet they still continued to throw good money into the abyss.
My feeling is, and please correct me if I'm wrong, if lending institutions were to offer favorable rates using good lending practices that we (when I say we I mean the country as a whole) may begin to get ourselves out of this quagmire we currently find ourselves in. After all, to borrow a semi cheesie term "If they lower them (interest rates), They will come" right?

m2c · Joined: 03 Aug 2005 Posts: 767

If you’re being sucked in by the “Fed rate at historic low” advertising, run the other direction. It’s illogical bait and you may get hammered. Movement in the “fed rate” may have no effect, an opposite effect, or a positive effect. How’s that for precision! All depends on the environment – for example in the 80s a drop in the fed rate brought on an ENOROMUS increase in mortgage rate; viewed as inflationary. In my opinion it’s very disjointed right now.

It’s a short-term/long (or rather intermediate-)term thing. Mortgages and the Fed are really at different points in the yield curve. Mortgages, or at least Fannie yields, are on a 12-year prepayment basis. So comes the 10-year treasury. Ah, but then there’s the “spread” which has had a high standard deviation of late and then (less of an effect now) the need to fill a CMO with a particular coupon.

Best shot is to look at the 10-year treasury yield but don’t believe in it 100%. The publicly available FNMA net yield is not bad for movement but what is publicly is posted only once per day.

IF (and that’s a capital “if”) you could be the MBS quotes, you’d have a better picture but it “ain’t a go’in be” except for, maybe, some “immediates” which are not really what potential borrowers are concerned with.

Ecommit is a good and current view but you’re not going to be able to “see” it and the market is MBS anyway.

Bottom line is there is no silver bullet. Even within the industry we’d like to see a central market for MBSs. I won’t even get into the different “screens”. In a high-volatile market I once say a 1/2 (price) differance in the primary dealer screen. That's HUGE!

cklimen · Joined: 25 Jun 2008 Posts: 3 Location: Walnut Creek, CA

Thanks for the speedy reply m2c!!
I've always had the understanding that what the fed does is eventually followed by most interest rates be it instantaneously or somewhere down the line? Is my line of thought not true? I was under the impression that mortgage rates can "temporarily" head in a different direction than the Fed funds rate and that the Fed funds rate should best be viewed as a sort of barometer rather than a defacto guide of where mortgage rates should be, but eventually, where the Fed funds rate is headed is the direction most interest rates are headed (even the 10-year treasury) right? I'm usually pretty good with numbers, and it bugs me that I seem to have so much trouble getting my head wrapped around how this all works - It all seems like a very screwie way of doing things.
Is this a better description of how it works: most interest rates follow the Fed funds rate - conditionally!? or should I lose the Fed funds rate correlation altogether?
Anyway, the Fed funds rate is the interest rate at which the Reserve Banks loan the money to the mortgage lenders that most of us get our mortgages from right? If this is correct, and the current Fed funds rate is 2% and the current National Overnight Average for a FRM is 6.3% (5.76% for a 5/1 ARM) doesn't the spread between the two leave a little "wiggle" room that can be adjusted and passed along to the consumer in order to give the market a little "kick-start" or is the spread eaten up in bank overhead?

cklimen · Joined: 25 Jun 2008 Posts: 3 Location: Walnut Creek, CA

I think I may have a grip on this thing now, it took me a bit of searching to find all the necessary information, then a bit more to write it all down in a fashion that I hope nearly anybody would understand. Please let me know if I'm still deluded. Also, please keep in mind that what I’ve written is a HUGE oversimplification of how interest rates are determined.

OK, here’s my attempt of describing how interest rates are determined in layman’s terms.
Text as displayed on my website:

“Who is the Fed Chairman?” and “what does he have to do with my home?” you may ask. The answer is both plenty and not a lot. To explain, here’s a greatly oversimplified description of how the Federal Reserve Chairman influences your interest rates: The Federal Reserve Board, of which the Federal Reserve Chairman is the speaker, meets 8 times a year (or more as warranted) to discuss inflation, U.S. market conditions, and other economic data. Depending on the outcome of this discussion, they will typically raise, lower, or hold even two key interest rates: the Discount Interest Rate which is the rate of interest the Federal Reserve charges to banks to whom the Federal Reserve itself loans money, and the Federal Funds Rate which is the rate of interest that the Federal Reserve “suggests” should be charged when one bank loans money to another. Neither of these two interest rates have a direct link with mortgage rates, however they do have an impact on the Mortgage Bond Market, which does impact mortgage rates (along with market demand, market stability, market solvency - the overall ability of people to pay their debt as viewed from a market perspective, and overall financial market conditions). The Prime Interest Rate, what banks charge their best mortgage customers (not typically what the majority of us qualify for), is based upon Mortgage Bond Market Yields adjusted for the conditions stated above, plus a margin added by the lending institution. The interest rate offered by banks to their average customers will be this Prime Interest Rate plus a percentage calculated by the bank based on how much risk they believe will be assumed in offering the loan to that particular customer. This risk is determined (but not limited to) some of the following factors: the number of years the owner has lived in the home, the amount of equity owned in the home, the amount of the loan, the home location, how much money the bank made or lost in the previous quarter, credit rating of the loan applicant, length of the loan, etc. The volatility of all of these factors impact how the Prime Interest rate and the interest rate offered to consumers are determined and are the reason why, at times, the interest rates set by the “Fed” will head one direction while the Prime Interest Rate will head another.

For the majority of us “average Joe’s”, treating the interest rates set by the “Fed” as a barometric tool to determine where mortgage rates are headed rather than using them as a defacto guide for the determination of mortgage interest rates themselves, is a better way to view the Fed’s changes because as far as the big picture is concerned, they basically follow the same path. For those who would like a more accurate snapshot of where mortgage interest rates stand and do not have instantaneous Mortgage Bond Market access, the 10-year Treasury Yield (readily available at CNBC, WSJ, Bloomberg, etc) is an acceptable albeit not instantaneously accurate gage for finding where mortgage interest rates lie.

freddyb45 · Joined: 28 Aug 2008 Posts: 15

Wow - some really helpful info there cklimen, thanks!