Highest Interest Rates in Generation Confront Everyone Without Fed Funding

http://www.bloomberg.com/apps/news?pid=20601213&sid=awcVIqSFgeJQ&refer=home

Highest Rates in Generation Confront Everyone Without Fed Funds
Email | Print | A A A

By James Sterngold

Jan. 26 (Bloomberg) -- Shannon Luhrsen, a stay-at-home mom in Wilmington, North Carolina, can't understand why she should pay 5.8 percent for her mortgage when her local bank gets money from the Federal Reserve at little more than 0 percent and the U.S. government is borrowing for 10 years at 2.6 percent.

“I want to get in the 4s,” Luhrsen said. “That would be fantastic. I don't want the bank to have my money. I want to have my money.”

The last time the disparity between 30-year mortgage rates and 10-year Treasury yields was so great during a period of Fed monetary policy loosening was 1982, when Timothy F. Geithner entered his senior year at Dartmouth College and Ben S. Bernanke was an assistant professor at Stanford University.

Until Geithner, President Barack Obama's nominee for Treasury Secretary, and Fed Chairman Bernanke figure out a way to narrow the spread, which would help shore up house prices, the economy will be in “quicksand,” said Clyde V. Prestowitz Jr., president of the Economic Strategy Institute in Washington and a counselor to the Secretary of Commerce during the Reagan Administration.

“We can't stabilize the overall economy until we fix housing prices, and mortgage rates are a huge, if not the biggest part of that,” Prestowitz said.

Maxine Waters, a California Representative and the No. 3- ranked Democrat on the House Banking Committee, also wants banks to lower mortgage expenses.

“If the government is making sure that cost is dropping for the banks, it should be dropping just as much for consumers, but they're not,” Waters said in an interview last week. “Banks could make loans at 4.5 percent, or even lower, and it would still be profitable.”

Rising Profit Margins

JPMorgan Chase & Co., the largest U.S. bank by market value, helps families purchase homes with long-term mortgages that they can afford and also assists them in refinancing existing mortgages to lower monthly payments, said David Lowman, head of home lending at the New York-based company. He wasn't more specific in a statement sent in response to questions about home- lending costs.

While the average 30-year fixed mortgage rate fell below 5 percent this month for the first time since McLean, Virginia- based Freddie Mac started keeping records in 1971, the banks' profit margins are increasing.

That's because the yield spread between 30-year mortgages and 10-year Treasury notes is 2.5 percentage points, compared with an average 1.7 points during the past two decades, data compiled by Freddie Mac and Bloomberg show. The difference was 3.3 percent on Dec. 3, the widest since 1986 when the Tax Reform Act eliminated real estate-related tax shelters, causing investors to sell properties and reducing market values.

FOMC Action

The Fed cut the benchmark interest rate six times in the past year. It was reduced last month to as low as zero to combat the longest recession since 1982 and revive the credit market. The Federal Open Market Committee said in a Dec. 16 statement that “weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.”

Fed policy makers twice pared the overnight lending rate to 1 percent since adopting it as the main tool of monetary policy in the late 1980s. The 1 percent held from June 2003 to June 2004, and again from the end of October until last month's reduction.

As rates dropped during the past 12 months, the gap between mortgage and Treasury yields approached 1982 levels. The gross domestic product contracted 1.9 percent that year, the worst performance since 1946.

Volcker to Bernanke

Former Fed Chairman Paul A. Volcker raised the government's target interest rate to 20 percent in 1980 and then again in 1981 to break the back of inflation as the economy sank into a recession. Inflation peaked at 14.8 percent in March 1980 and declined to 3.8 percent by the end of 1983.

Efforts by Bernanke, 55, to reverse the two-year drop in home prices and the economic slump depends in large part on banks lowering rates enough to stimulate loan demand. His attempts are so far having little effect. Analysts estimate the economy will contract 1.5 percent in 2009, a half percentage point more than projected a month ago, according to a survey compiled by Bloomberg last week.

JPMorgan and Charlotte, North Carolina-based Bank of America Corp., the country's biggest home lender, said the industry is changing the terms of existing mortgages to keep Americans in their homes as job losses spread across the nation.

Jamie Dimon, JPMorgan's chief executive officer, said in a Jan. 15 statement that the company has prevented more than 300,000 foreclosures, and “we plan to help more than 300,000 more families keep their homes through mortgage modifications over the next two years.”

Adjustable Rates

Bank of America will adjust more than $100 billion of existing home loans to keep as many as 630,000 borrowers from defaulting over the next three years, CEO Kenneth D. Lewis said during a Jan. 16 conference call after the company reported a fourth-quarter loss of $1.79 billion.

In the current business climate, “rates should be 4 percent, not 5 percent,” said Lawrence Yun, chief economist of the National Association of Realtors, a lobbying group in Washington.

Spreads are even wider for adjustable-rate mortgages. The average 1-year ARM is almost 5.8 percentage points above three- month Treasury bill yields, the biggest gap ever, and far above the historical average of about 2 percentage points, according to Bloomberg data. The difference peaked at 6.9 percentage points on Sept. 16, after the bankruptcy of New York-based investment bank Lehman Brothers Holdings Inc.

Luhrsen's Lament

“Mortgage rates are probably 25 to 50 basis points too high, once you factor everything in,” said Laurie Goodman, an economist and senior managing director at Amherst Securities Group LP in Austin, Texas.

She estimates the wider spreads mean banks making loans of $300,000 and then selling the mortgage on the so-called secondary market are earning about $6,240 more than they did as recently as three years ago when the housing market was booming.

Luhrsen, the 40-year-old mother of two in Wilmington, North Carolina, said she wants to refinance her 30-year fixed loan and checks the Internet every other day for a lower rate. The best she can do is a little more than 5 percent.

“I want to get as low a rate as possible,” Luhrsen said.

No matter how far rates fall, borrowers always want them lower, said Chris Hutchens of Alpha Mortgage Corp., Luhrsen's mortgage banker in Wilmington.

“If it goes to 5, people will want it to go down to 4, and if it goes to 4, they want 3,” Hutchens said. “I want to say, 'Hey, it's not going to zero.' But that's what everybody wants.”

Geithner Hearing

The increase in costs runs contrary to programs supported by Obama, who said in speeches during the past month that “we've got to start helping homeowners in a serious way.”

Geithner, 47, said Jan. 21 at a Senate Finance Committee hearing that the new administration will propose a “comprehensive plan” within the next few weeks to respond to the economic and financial crises. It will address the credit crunch, the collapse of the housing market and the global economy, he said.

Stan Sieron, a realtor in the St. Louis suburb of Belleville, Illinois, said that, with banks able to borrow overnight at almost nothing and the Treasury pouring record amounts of capital into the financial system, mortgage rates of 5 percent are doing little to stabilize prices or attract new buyers to soak up the excess supply of homes.

“I do think banks could go much lower, to 4 percent or so now,” Sieron said. “It's not just rates, though. They're really tightening up lending. People I know are having an extremely difficult time getting loans. Everything is an issue, and there are too many 'no's.'”

Prices in Freefall

Home prices in 20 major U.S. cities have declined at the fastest rate on record, depressed by mounting foreclosures and slumping sales. The S&P/Case-Shiller Index dropped by a more than estimated 18 percent in the 12 months through October. The gauge has fallen every month since January 2007.

Foreclosure filings rose 81 percent last year as companies slashed payrolls by almost 2.6 million, the most since 1945, the Labor Department and Irvine, California-based research group RealtyTrac Inc. reported.

“A lot of people working at mortgage companies are dealing with defaults, not originating new loans,” said Goodman of Amherst Securities.

Financial institutions have reduced risk-taking after more than $1 trillion of writedowns and credit market losses since 2007, triggered by record subprime home-loan defaults in the U.S., data compiled by Bloomberg show.

Stricter Standards

With lenders tightening standards, as few as 50 percent of applications are resulting in mortgages this month, down from an average of about 70 percent during the past 18 months, according to analysts at Zurich-based Credit Suisse Group AG.

Banks are so traumatized by their losses that they're reluctant to narrow lending spreads or extend loans, said Douglas Duncan, chief economist at Fannie Mae, the Washington-based mortgage buyer seized with Freddie Mac in September after federal regulators determined the companies were at risk of failing.

“Underwriting criteria have been tightened considerably, and that is a real issue,” Duncan said. “Mortgages could well be close to 4 percent if they reflected traditional spreads. It's not greed or things like that. It's the real risks the banks see.”