Rates Will Go Up....

Monday, February 15, 2010 (SF Chronicle)
Mortgage rates poised to jump as Fed cuts funds
Carolyn Said, Chronicle Staff Writer


The Federal Reserve is poised to turn off a major money spigot that has
helped sustain the ailing real estate sector, as an extraordinary program
under which the Fed has pumped $1.25 trillion into the mortgage market is
slated to end March 31.
"Housing has been on government life support, and without it the crash
would have been much more severe," said Mark Zandi, chief economist with
Moody's Economy.com in Pennsylvania. "This spring and summer as those
policy efforts unwind, we most likely will see mortgage rates move higher
and more house-price declines."
Rather than being held by banks, today's mortgages are sliced, diced and
resold on Wall Street to create liquidity - money that then can be lent in
more mortgages. After the credit crunch beginning in the fall of 2008,
investors lost their appetite for these mortgage-backed securities, so the
Federal Reserve stepped in to purchase them to ensure that money would
keep flowing to home purchasers.
The Fed started buying securities backed by Fannie Mae, Freddie Mac and
Ginnie Mae in January 2009 and originally planned to conclude the program
by year's end. It extended it for three months to ease the impact on
mortgage markets, although it didn't allocate more money. The program's
ultimate cost won't be known until the Fed sells off the securities,
something that officials said it will do gradually starting this year.
It's conceivable that the program could end up generating a modest profit,
breaking even or losing money, depending on what prices the securities go
for.
While experts agree that the Fed's exit will cause mortgage rates to rise,
the big unknown is how severe the effect will be.
"There is no question rates have been kept artificially low by the Fed's
heavy buying," said Guy Cecala, publisher of Inside Mortgage Finance. "My
opinion is that rates will go up a full percentage point initially,"
meaning that 30-year fixed conforming loans, now hovering around 5
percent, would hit 6 percent.
Keith Gumbinger, vice president of HSH Associates, which compiles mortgage
loan data, thinks that rates will slowly rise to about 5.75 percent after
the Fed withdraws.
"Right now the Fed is acting as a sponge, absorbing about $12 billion a
week of what you might consider excess supply," he said. "When they stop,
the market will have to pick up some chunk of change."
Julian Hebron, branch manager at RPM Mortgage's San Francisco office,
anticipates a bump up to around 5.5 percent by summer with rate volatility
all year.
"The Fed isn't going to start dumping mortgage bonds on April 1, they're
just going to stop buying," he said. "By that time, improving economic
data is likely to push the Fed toward a rate hike bias. This will
contribute to higher mortgage rates, slowing refi activity, and less
mortgage bond supply. So while the Fed won't be buying anymore, rates
shouldn't spike immediately because there will be less supply for markets
to absorb."
Christopher Thornberg, principal at Beacon Economics in Los Angeles,
thinks the Fed's withdrawal will have a radical impact.
"Clearly, when they stop printing all that money, it's going to be a shock
to the system. I have to assume that when they pull back on it, it will
cause a 100- to 200-basis-points rise" to rates of 6 percent or 7 percent,
he said. "When they start selling off the stuff they purchased, which by
my guess would come early next year, that would cause another 100- to
150-basis-points rise."
The Fed has indicated that it might resume buying mortgage-backed
securities if mortgage rates spike.
In written Congressional testimony released last week, Fed Chairman Ben
Bernanke said the Fed eventually will take steps to forestall inflation
that also are likely to result in higher interest rates for all loans.
Several other government programs designed to prop up the housing market
also are in play:
-- The home buyers tax credit of $8,000 for first-time buyers and $6,500
for repeat buyers expires April 30. Although many experts think the
program simply caused people to buy houses earlier than they had planned,
its end is likely to cause a dip in home sales.
"Higher interest rates without a tax credit means the cost of buying a
home will rise significantly," Zandi said. "We should expect much weaker
home sales in May, June and July."
Cecala thinks that if home sales are anemic, Congress may extend the tax
credit an additional six months, as it's already done once before.
-- Federal Housing Administration loans, an increasingly important source
of financing for many borrowers, especially those with low and moderate
incomes, imposed more stringent lending criteria in January. As FHA
delinquencies rise, the rules could tighten still more, eliminating some
potential buyers.
"The FHA portfolio has all sorts of bad debt in it," Thornberg said.
"Eventually they'll have to pull back" on lending.
-- Home Affordable Modification Program, the government-backed plan to get
banks to help troubled homeowners, has kept the market from being flooded
with foreclosures, as hundreds of thousands of borrowers are negotiating
with their lenders for lower payments. Eventually, observers say, much of
that backlog will wind up in foreclosure because homeowners simply don't
have the income or ability to make modified payments. A new surge of
bargain-basement foreclosures would undermine home prices.
"We have a boatload of homes that ultimately will find their way to a
foreclosure sale, and that will put pressure on house prices," Zandi said.
"The more that distressed home sales rise, the more home prices get pushed
down."

E-mail Carolyn Said at csaid@sfchronicle.com. ----------------------------------------------------------------------
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