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FloridaCMPS (< 20)

Will Mortgage Rates be the Next Bubble?

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December 16, 2008 – Comments (0)

There has been a lot of brew-ha surrounding the 4.5% mortgage rates Treasury Secretary Henry Paulson stated was his desire as another {senseless} effort to boost the housing market and ultimately the economy.  Real estate and mortgage bloggers, hell any blog that wanted to get some action, was posting something with that 4.5% statement in it, and a wide variety of opinions can be read.  My own take is located here...Florida Mortgage Rates Hit 4.5%.

Now, regardless of how you feel overall, one need be concerned only with how we get to mortgage rates this low, especially when fundamentals are not sound.  Mortgage rates are derived from mortgage backed securities, nothing else, and those are traded on the open market like any stock, commodity, even currency.  Since mortgage backed securities are basically bonds, they tend to respond to the same things as other bonds.  That means data supporting a weak economy tends to drive mortgage bond prices higher and thus bring mortgage rates lower.

In essence, the fundamentals which should be driving mortgage rates are surrounding a poorly performing economy, which no doubt we have been seeing, especially now that the NBER declared we have been in a recession for the last year. However, the so-called archenemy of mortgage bonds, and thus mortgage rates, is inflation, which every effort that the government does during these attempted bailouts increases inflationary risks, including the inevitable cut in the Fed Funds Rate.  I will be adding a post later tonight or tomorrow talking about how inflationary rates could reach 20%, so you may not want to miss that one.

Currently, as economic data flows, most signs point to a weak economy and mortgage rates have been dropping as a result.  The government's desire for the 4.5% rates isn't even the chief cause of concern, though it is up there as anytime markets get manipulated, crashes occur.  Just look at the fallout coming from the most recent scandal by Bernard Madoff.  The deeper concern is the lack of foreigners buying up mortgage backed securities which has been a major reason mortgage rates have dropped in the past.  Simple supply and demand rules show the reason for concern here.

What it all boils down to is this, the Treasury Department and the Federal Reserve will most likely be the only buyers of mortgage backed securities soon and that will artificially drive mortgage rates down.  Once they have achieved their goal, and stop wasting taxpayer money to do so, they will be caught holding "worthless paper" and stuck with huge losses as mortgage bond prices come crashing down.  When that happens, guess what?  Yep, mortgage rates will go through the roof.

Here are some other mortgage professional's thoughts on why they feel the mortgage rates may very well be the next bubble to pop (via Twitter submissions)...

"Mortgage rates will be the next bubble. Gov't can't suppress below market yields & dictate loan mods w/o impacting investors." - James K. Barath (aka mycmps)

"MR next bubble - yes I think they could be - fear of buying MBS and value of the dollar wrecking havoc on credit markets..." - Tom Vanderwell (aka tvanderwell)

As you can see, some of the top minds in the mortgage profession are thinking the same thing.  What I like about Tom's input was that he eluded to the devaluing of the dollar, which is a huge part of the problem, hence inflation of 20% as I will show in my next post.  For now, the government's ineptitude for creating money is devaluing the dollar which will cause inflation.

I am a big time "visual investor", meaning I decipher charts to determine the direction of mortgage rates.  Right now, the charts look good, but they could change quickly at any given moment in a market as volatile as this.  With mortgage rates about the lowest we have seen in five years, one can only wonder how long they can remain down here without artificial propping. 

With Pimco's announcement today that they will also be buying mortgage backed securities (which they announced months ago as well), demand does not appear to be a problem right now despite the lessening foreign participation.  However, Pimco may very well just be trying to "ride the gravy train" as the government keeps driving prices up themselves.  Heck, why not?

Only time will tell for sure, but the mortgage backed securities market does look poised to be setting up for a crash.  More than likely, the dollar will begin to collapse just prior, which there are plenty of signs showing that may have already begun.  Who will be to blame?  The government, yet again, for its "divine interventions".

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