Why Today's Interest Rates Defy Economic Gravity
by Peter G. Miller
The news on the mortgage front goes like this: According to Freddie Mac interest rates are at their lowest levels in six months -- 5.69 percent with .7 points for fixed-rate financing, 4.02 percent plus .7 points to start adjustable-rate mortgages (ARMs). These are "Janus" numbers. Janus, in Roman mythology, had two faces -- a smile and a frown. The interest rates we're now seeing are surely good news for those who want to finance and refinance, but they also raise a discomforting question: Why is the mortgage market awash with so much cash? The stock market, we're told, is a predictor of future events, things that will happen six months down the road. If that's the case, and assuming investor sentiment is on the mark, plan for an April vacation because times should be woeful. Friday the Dow Jones Industrial Average closed at 9,757.81, down from the 10,409.80 we had on January 1st. The Dow is also below 10,587.50. That's where the index stood on January 19, 2001, the day before President Bush was inaugurated. We're not at the mortgage low for 2004 -- that took place in August. But you have to bet that a lot of people are moving money away from the stock market and into comfortable, stable bonds, one reason why so much cash is now available for mortgages and rates are so low. As a property owner and someone who believes that refinancing at a lower rate is a natural right, I'm greatly pleased to see lower mortgage levels. However, the rates we're seeing today defy economic gravity, a view which suggests that rates will shortly head higher. Why? There are only so many dollars to go around unless we're willing to print more and devalue our currency. If we spend money on one thing there will be fewer dollars to spend elsewhere. So when the federal government runs up a record deficit of $413 billion -- as it has in the just-ended fiscal year -- that means Uncle Sam has been scrounging up capital that could have been used elsewhere. With fewer dollars for other things, such as mortgages, you would expect loan rates to rise. When gas prices soar it means we're effectively paying a huge national sales tax to OPEC. Prices across the economy will rise as everyone tries to re-capture higher gas costs from consumers, thus impacting inflation pressures and mortgage rates. Next we come to Freddie Mac. Here's a company -- the nation's second-largest mortgage owner -- that managed to earn billions of dollars in profits it did not report, a problem in some respects we should all have. For 2003 Freddie Mac earned $4.9 billion, a huge amount to be sure but down 52 percent when compared with the $10.1 billion earned in 2002. Given Freddie Mac's accounting issues and 2003 results, would not mortgage risk increase and rates rise? Can it be argued that Freddie Mac is irrelevant in the mortgage-valuing process? We also have recent allegations regarding Fannie Mae, the nation's largest mortgage buyer. The Office of Federal Housing Enterprise Oversight (OFHEO), the federal agency which regulates both Fannie Mae and Freddie Mac, says Fannie Mae has agreed to address "improper accounting and inadequate controls." Alternatively, the chairman of the Securities & Exchange Commission, William H. Donaldson, has been quoted in news reports as saying that the accounting issues associated with Fannie Mae are neither simple nor "black and white." (See, as an example: "Fannie's Issues: Simple or Not?," The Washington Post, October 23, 2004) Again, do investors prefer turmoil? Will disputes and debates spur higher rates? If Fannie Mae is important to the mortgage marketplace, why are rates falling in the face of accounting allegations? (To make matters more complex, OFHEO itself has been the subject of a HUD investigation to see if it has been unduly influenced by political considerations. The report has not yet been released, despite bi-partisan inquiries on Capitol Hill.) Conspiracy buffs will suggest that the low rates we're now seeing result from political manipulation, that after election day rates will suddenly rise. This is a fun theory and it may well happen that rates will quickly rise after election day, but the mortgage marketplace is huge and relies on factors which cannot be controlled -- such as the volume of foreign capital coming into the U.S. Also, if manipulation on a grand scale was possible, would not stock prices be higher today than they were when the President took office? That just isn't the case. The bottom line looks like this: Now is a dandy time to be in the marketplace if you need financing. While rates are not as low as when interest levels hit a 45-year bottom in June 2003 (5.21 percent with .5 points), it's also true that today's rates are parked at a level rarely seen during the past four decades. No less important, it's hard to believe that interest rates will remain at today's levels. In the near future either rates must rise or we'll need to re-write a whole bunch of economic textbooks. | 
