Dennis' Mortgage Blog

Question of the week:  What exactly is “The Fed?”

Answer: “The Fed” is vernacular for The Federal Reserve System, America’s central bank.  The Fed was established by Congress with the purpose of making the country’s banking and monetary systems safer, more flexible and stable.  As with most government bureaucracies, the Fed today has much broader purpose and authority than when it was established in 1913.

The Fed has regulatory powers over banks and other financial industries, facilitates the movement of funds between banks, has direct impact on how much money is in our economy and operates free from oversight from any branch of the Federal Government. 

The Fed is directed by a Board of Governors, of which there are seven all appointed by the President.  The Board of Governors oversees a system that consists of twelve Federal Reserve districts.  Each district has a bank through which currency is distributed to commercial banks, payment systems are operated for transferring funds between banks and exercising supervisory and regulatory powers over financial institutions in the district.  California is in the twelfth federal reserve district.

My weekly updates mention the Fed frequently because of the impact its actions, and often non-actions, have on mortgage rates and the economy.  Mentioned far less frequently is the impact the Fed has on the financial industries, including the mortgage industry, through its regulatory actions.

In any economy the monetary supply, how much money is actually in the economy, and how it moves through the economy is a fundamental element of the economy’s performance.  Too much money and there can be inflation with rising prices that lead to a collapse due to unsustainable markets, too little money and the economy falls into recession with high job loss and a cycle of high unemployment creating less economic activity leading to more unemployment.

Our money supply is controlled by three policies, fiscal policy which is action by the federal government, monetary policy which is action by the Federal Reserve and actual money in circulation controlled by the Treasury Department who runs the U.S. Mint’s printing presses.

The Fed can increase or decrease the amount of money in circulation by changing the amount of reserves banks must have on hand in relation to loans outstanding, increasing or decreasing the rate is charges member banks to borrow money from the Federal Reserve, or purchasing or selling financial instruments such as Treasury bonds—or mortgage backed securities. 

For the past three and a half years the Fed has been aggressively putting more money into the economy, almost two trillion dollars, to stimulate the economy and try to engineer sustainable growth.  It has done this with several moves.  Quantitative Easing (or QE) has gotten the most publicity buy purchasing over one trillion dollars in federal debt and mortgages.  This policy’s theory is that by injecting large sums of money into the economy it will circulate through businesses and households purchasing goods and services.  This leads to more economic activity and eventually businesses will hire and expand and the economy will grow.

Interest rates are another way the Fed can impact the circulation of money in the economy.  Lowering its lending rate to near zero, the Fed has allowed banks to borrow money at literally no cost and then lend it at higher rates.  The principle behind this policy is that with no costs banks will be more willing to lend money, putting more money into the economy for companies and individuals to expand and purchase goods, like houses. 

What has confounded the Board of Governors, at least publicly, and many pundits and politicians, is that the several trillion dollars poured into the economy in the past three and a half years by the Fed and the federal government through deficit spending has not had near the intended impact.  After this period of time with the extra money in the economy and low interest rates not only should our economy by growing at over four percent per year but the Fed’s primary concern should be inflation and looking to decrease the money supply with higher rates and selling bonds instead of buying them.

Because none of the actions thus far have led to acceptable economic growth and lower unemployment, speculation is that the Fed will engage in another round of Quantitative Easing.  This will have the same impact as QEI and QEII in that it will push commodity prices up, increase profits for financial institutions and keep interest rates at their low levels. 

Unfortunately the Fed does not control fiscal policy.  Fiscal policy is controlled by Congress and the White House through tax policy and spending.  Because of the uncertainty created by Washington for businesses as to future costs for taxes, healthcare, regulatory compliance, businesses, and households, are retaining the money put into the economy and not spending it.  This has created a tremendous surplus of cash in our economy that is stagnant.  Once the uncertainty is lifted the cash will begin to circulate and I will be writing about the Fed raising interest rates to try to control inflation.

What is the Fed?  The single most powerful economic institution in the world, controlled by seven individuals who are accountable to no political body.

Have a question?  Ask me!

OPA! Greek elections have resulted in a new Prime Minister, their fourth in eight months I think, choosing as a leader the candidate who vowed to follow the austerity program put forth by the rest of the European Union (read: Germany) and therefore stay in the Eurozone.  Will this solve their problems? No, but it gives them a chance to solve their problems or at least mitigate the damage they will do to the rest of Europe.

Status quo in economic data this week, and that is not a good thing.  Initial unemployment claims continue to inch back toward 400,000 per week and the Philly Fed economic report (see above, Philadelphia one of the twelve districts) reported disappointing numbers for economic growth in the region.  With several months of reports showing a very stagnant economy the concerns for those with economic degrees (your truly included) is that the economy will either fall back into recession or with the abundance of excess money in the economy (see above) we will enter a period of “stagflation.”  Stagflation is when there is climbing inflation raising prices for consumers and businesses alike but no economic growth to absorb the inflation; perhaps one of the most dangerous and difficult economic conditions from which to recover.

The Fed announced this week that it is concerned about the lack of economic growth and a job market that continues to flounder, so it is going to do…..nothing!  Which is welcome news to me and others who feel the economic turnaround will not come from more money from the Fed or the government but rather from an increase in confidence from business owners and households.  What the Fed will continue to do, which I do support, is “the Twist.”  No, we are not going to see YouTube videos of Chief Bernanke and the other Fed governors playing Chubby Checker and dancing. “The Twist” is conversion of Fed holdings of short term Treasury debt into long term Treasury debt to hold down long term rates.  What this means is that when current 6-month or 1-year T-bills that are owned by the Fed are paid off the Fed will take the funds from the payoff and purchase 10 and 30 year bonds.  I like this idea because it locks in low interest rates for future taxpayers on the $1.5 trillion plus the government is borrowing each year to fund its deficit spending.  (I would like it even more if there was not a $1.5 trillion deficit as there has been each of the past three years.)

Rates for Friday June 22, 2012:  What does all this mean for mortgage rates?  As always when the Fed makes an announcement of any kind, rates jumped up on Wednesday and settled back some on Thursday.  Here is our look at rates for this Friday.  Look at the stability of the rates the past six weeks, that is what we like to see—stable rates.

FIXED RATE MORTGAGES AT COST OF 1.25 POINTS

30 year conforming                               3.375%             Flat

30 year high-balance conforming           3.625%             Flat

30 year FHA*                                       3.25%               Flat

30 year FHA high-balance*                   3.5%                Flat

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked.  Rates are based on 20% down (3.5% for FHA)  with 740 FICO score for purchase mortgages.

* Current rates include credit towards closing costs, call for quote on rate and credit.

Our industry is going through a period of very high volume.  Refinances are heavy with a large increase due to the HARPII program and lower MI rates for qualified FHA homeowners and we are seeing a large increase in purchase volume.  As a result timeframes are getting stretched as every step of the process from initial inquiries through processing, underwriting, docs and finally funding is pushing capacity.  With that in mind I share this story I shared yesterday with a couple of clients as we went through a crazy morning of getting final approval and loan documents to beat a deadline.

Many, many years ago a real estate agent who has been in the business about 35-40 years said, “Dennis escrows are like pregnancies, they have a due date. Some are early, some are on time and some are late but almost all end as expected.”

I replied, “You know Marilyn you are right, escrows are like pregnancies.  There is a lot of activity in the beginning to get it started, then a period where not much is seemingly going on, and then a lot of activity at the end.”

I will be unavailable the next two mornings as I try to overcome my horrible start last Saturday to a three day golf tournament at the El Dorado Park Golf Course Men’s Club.  Whether I do or not overcome my current near last place standing I will be enjoy the five mile walk with a twenty pound sack Saturday and Sunday mornings and hope the result is as enjoyable!

Have a great week,

Dennis