Dennis' Mortgage Blog

Question of the week:  What does it mean with the Federal Reserve raising its “discount rate” yesterday?  Will my rates go up?

Answer:   Yesterday, 2/18/2002, the Federal Reserve (the Fed) announced it was increasing its discount rate from 0.50% to 0.75%.  The announcement was late in the afternoon on the East Coast, after the stock markets had closed, and was meant by the Fed to be a somewhat non-issue.  Au contraire Messieurs Le Fed.  Immediately the Mortgage Backed Securities and bond markets (which were still open) dropped, a lot.  Joining in the price shedding were the futures markets for stocks.  The quiet reaction expected by the Fed was quite the opposite.

So what does it mean?  Initially for consumers and most Americans the move has little impact, except as impacted by the overall market reactions, i.e. stock and bond prices reaction.  But credit card rates, auto loan rates, equity line rates, all are connected not to the discount rate, which was raised, but the federal funds rate—which was left untouched and per the announcement made with the increase yesterday will remain untouched for “an extended period.”

Also the Fed announcement said the increase in the discount rate does not “signal any change in the outlook for the economy or monetary policy…not expected to lead to tighter financial conditions for households or businesses.”

How can they say this?

The discount rate is for emergency loans from the Federal Reserve to member banks that are short on liquidity and reserves, when in trouble they would go to the discount window, as it is known, and borrow money at the discount rate.  Prior to the current fiscal crisis member banks would avoid as much as possible borrowing from the discount window and it carried a negative stigma to do so.  The Fed wants this stigma to return and wants banks to not rely on federal funds for their borrowing and liquidity but instead use the markets and other banks.  Raising the discount rate to 0.75% increases the gap between the discount rate and the federal-funds rate to 0.50%, which should encourage less borrowing from the discount window.

The federal-funds rate is the rate banks charge each other for overnight loans, the preferred borrowing tool the Feds want banks to use.  It has been between 0- 0.25% for over a year now and per the Fed will continue there for that “extended period.”  This is the rate, the federal-funds rate (or fed funds) that banks use to set the Prime Rate which is the basis for home equity lines of credit and many credit cards.  With this rate remaining unchanged, the Fed can say that consumers and businesses are unaffected by yesterday’s move.

The increase in the discount rate was needed.  Borrowing from the discount window had dropped from over $100 billion outstanding in 2008 to only $15 billion earlier this week.  Banks had been able to borrow money at 0.25% on the funds rate and lending it out at higher rates, making some tidy profits.  This borrowing-lending cycle has done much to increase the financial health of the country.  Now that good health is attained it is time to reduce some of the medicine.

Looking forward the move to tighten credit on the banks for emergency loans and force them to be less reliant on the discount window signals the Fed is on the path to higher rates across the board.  Everyone knows rates will increase, the questions have been when, how much and how often?  The current bets are that the Fed will raise the federal-funds rate, the rate that impacts consumer and business loans and credit, at least twice by the end of the year. 

If you have a home equity line of credit you have been enjoying a very low interest rate, don’t get too cozy with it as it will go up this year when the Fed does raise the fed funds rate.  If you have and adjustable rate mortgage, your rate has been low as well as LIBOR, MTA, T-bills, and other indices have been extremely low—but will increase as higher rates trickle through all the markets.  If you are able I advise you to pay down as much on principal as you can before rates increase to mitigate any increase in payment you will see from rising rates later in the year and into 2011 and beyond.

Have a question for me?  Ask me!

One last reminder FHA condo buyers effective Monday no more spot approvals and many complexes that were approved will have to go through re-approval process. 

This has been a rockin’ week for economic data.  Wednesday had a lot of low and medium impact data on housing starts (up), permits (down), industrial production (up), capacity utilization (up) and MBS were flat until late in the day.  It was a warm up act.  Thursday the main news hit the stage:  Producer Price Index, wholesale costs, was up well above expectations.  Wholesale prices are up 4.6% for the year and 9.8% for the past six months.  Also yesterday initial jobless claims came in at 473,000 initial claims, above expectations and 31,000 ahead of last week’s number—which was briefly celebrated as “low”. Yesterday’s number puts the four week average higher than many expected, or want.  Finally came the late market punch of the increase by the Fed of the discount rate.

The Mortgage Backed Security market reaction was not a surprise.  Many economists, myself included (though technically not an economist by trade I do have degree in economics), feel the worst economic cycle a country can enter is one with combined job loss and inflation.  To stimulate growth and job creation low rates and access to credit are needed.  To fight inflation high rates and tight credit policies are needed.  So how much inflation is acceptable to allow for putting Americans back to work?  How tight can credit get and still enable businesses to expand and grow and hire more workers?

Markets hate uncertainty.  That is a standard axiom that is time tested and proven.  When there is uncertainty people will not invest, will not spend except on necessities and hold (horde?) their money.  This seizes markets and the flow of goods and services slows significantly.  This is what has been occurring in our economy for the past year.  Personal spending is down and savings is up.  Long term this is a much needed mind-set for Americans.  Short-term it delays economic recovery and growth. 

The challenge for the government and regulators is how to free up the markets to borrow, lend, invest and grow without creating an environment that spurs inflation even higher.  The primary way to do this is eliminate as much uncertainty as possible.  The past year has seen anything but certainty coming into the markets.

This week in rates popped 0.125%, except FHA, with almost all of it coming from yesterday’s market activity.

Rates for Friday February 19, 2010:

FIXED RATE MORTGAGES AT COST OF 1 POINT*

30 year conventional 4.875%                            Up 0.125%

30 year conforming-jumbo 5.125%                   Up 0.125%

30 year FHA    4.75%                                      No Change

30 year FHA jumbo 5.125%                            Up 0.125%

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, and period rate is locked (i.e 45 days instead of 30 days).

Please note that rates quoted are based on average of several lenders for a purchase transaction with 20% down payment and a minimum FICO score of 740; APR is not quoted as it is dependent upon specific loan amounts, lenders and services selected.  Numbers provided are for comparative purposes only.

Eight years ago this evening I was at the office and Leslie called, “I think tonight maybe the night, can you stop by Le Yen’s and pick up some dinner?”  I got home with the dinner and barely had time for a few strands of chow mein.  We called her sister, Kelly, and packed Blaire a bag for one or two nights.  About 8:30 Kelly arrived and picked up Blaire.  Leslie and I headed a short way down Atlantic and headed into Memorial Hospital.  After a brief wait, with no one there which frustrated me immensely, we were shown into a room.  A nurse came in and said, “whoa, you’re close!”  I left to go park the car in the lot and went back into the room.  As I walked in I heard the nurse say, “We’re there, I can see the head!”   A minute later a diminutive resident from UCLA walked in and basically caught our new daughter.  Had I not found a parking spot right away I would have missed it!

Happy Birthday Jenna!  You wasted no time joining our family and all the smiles and laughs you share with us every day!

Have a great weekend, let me know how I can be of service to you,

Dennis