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Select Few Are Helped By Rate Drop


The odds of a huge number of people in 15 year fixed rate mortgages benefiting by this drop in the Fed Funds Rate is pretty slim.


Curve Watchers Anonymous is watching the yield curve, mortgage rates, and LIBOR following the emergency rate cut of 75 basis points. For more on the emergency cut please see Bernanke Blinks.

Yield Curve January 22, 2008

Click to enlarge.

Ten year treasury yields have dropped precipitously, especially since mid-summer. One might think that mortgage rates would be dropping like a rock. Are they? If they are, who is benefiting? Let's see if we can figure this out starting with LIBOR.

LIBOR Rates January 22, 2008

Click to enlarge.

LIBOR has fallen steeply. But with additional rates cuts priced in, including the possibility of another cut later this month, concern over bank to bank lending has not gone away entirely. 3 month LIBOR should be at or below the Fed Fund Rate, not above it. As far as mortgages go, only those in LIBOR based ARMs will benefit from this drop. We will explore this in depth in just a bit.

Mortgage Rates January 22, 2008

Click to enlarge.
The above charts courtesy of Bloomberg.

$TNX 10 Year Treasury Weekly Chart

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Fixed rate mortgages tend to follow the 10 year treasury note, at least in theory. Looking at the above chart, mortgage rates should be 120 basis points below where they were a year ago.

The above table shows 15 year mortgages are only 62 basis points lower than last year, with 30 year mortgages a mere 34 basis points lower than a year ago. 1 year ARMs are essentially flat compared to a year ago.

The following three charts are courtesy of TheFinancials.Com.
Freddie Mac 3/1-Yr ARM 36-Month: January 17, 2005 to January 17, 2008

Click to enlarge.

The above chart shows that few in 3/1 ARMs about to reset will benefit from these rate cuts. Those in one month LIBOR loans or interest only LIBOR loans, are benefiting but only to the extent they are getting back to where they started.

Freddie Mac 30-Yr Fix 36-Month: January 17, 2005 to January 17, 2008

Click to enlarge.

The above chart shows few in 30 year fixed rate mortgages can benefit from this drop by refinancing.

Freddie Mac 15-Yr Fix 36-Month: January 17, 2005 to January 17, 2008

Click to enlarge.

The above chart shows that some could theoretically benefit from the decline in 15 year fixed mortgage rate. However, except for those buying at mortgage spikes, the benefits would be small and involve refinancing fees as well.

In addition, falling home prices, tightening lending standards, and higher down payments will all take their toll on who can gain by refinancing. All things considered, the odds of a huge number of people in 15 year fixed rate mortgages benefiting by this drop in the Fed Funds Rate is pretty slim, especially since the pool of possible beneficiaries is primarily for the last 18 months or so.

Thus, the only people really benefiting from this drop so far are those currently in interest only mortgages, pay option ARMs, or other ARMs specifically tied to short term LIBOR. For those in Pay Option ARMs, this benefit may do nothing but postpone the day of reckoning. This is especially true for Option ARM holders who are only able to afford the minimum payments and are going deeper in debt every passing month due to negative amortization. For the rest, the benefit is real. However, this just puts people back to where rates were a couple years ago.

Conclusion: 175 basis points of rate cuts at best amounts to nothing but treading water when it comes to helping the mortgage crisis.

The Red Queen Race

In Lewis Carroll's Through the Looking-Glass there is an incident involving the Red Queen and Alice constantly running but remaining in the same spot. The scene is often referred to as The Red Queen's Race.

The Queen kept crying "Faster!" but Alice felt she could not go faster...

"Now! Now!" cried the Queen. "Faster! Faster!" And they went so fast that at last they seemed to skim through the air, hardly touching the ground with their feet, till suddenly, just as Alice was getting quite exhausted, they stopped, and she found herself sitting on the ground, breathless and giddy. The Queen propped her against a tree, and said kindly, "You may rest a little now."

Alice looked round her in great surprise. "Why, I do believe we've been under this tree all the time! Everything's just as it was!"

"Of course it is," said the Queen: "what would you have it?"

"Well, in our country," said Alice, still panting a little, "you'd generally get to somewhere else -- if you ran very fast for a long time, as we've been doing."

"A slow sort of country!" said the Queen. "Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!"

The above image and text is thanks to the University of Virginia Library.

Bernanke, like the Red Queen and Alice, simply cannot run fast enough when it comes to bailing out this mortgage mess.


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