What the rate cut means: A dissenting opinion

(Note: this is an edited version of an earlier post)   A reader e-mails to disagree with my earlier post minimizing the impact of today's rate cuts on mortgage rates. That post quoted CNBC's Diana Olick, who wrote,  "I’ve said it before, and I’ll say it again: the 30-year fixed is not tied to short-term treasuries. ... Fixed mortgage rates are tied to long-term bond yields that move based on the outlook for the economy and inflation. And guess what? The long-term outlook for the economy isn’t exactly rosy right now. Today's rate cut does affect short-term adjustable rate mortgages, but not really as much as you might think. Why? Because this rate cut was already priced into the market..."

Now the dissenting opinion: "The lender I work with at Bank of America in Glendale told me this morning that she is reducing the interest rates for the pre-approved buyers I'm working with .25%."  In other words, the rate cut meant lower mortgage rates immediately.

Further, the dissenter points to this article in USA Today, which also points to immediate benefits of lower rates in the mortgage market: "The Fed's rate cut will also give the biggest boost to borrowers with variable-rate mortgages, says Keith Gumbinger, vice president of HSH Associates, which tracks mortgage rates. Home equity loans, which are typically half a percentage point above the prime rate, should fall to about 7% from an average 7.74% the first of the year, he says."

Why the edited version? A reader observed the illustration for the original post was "too tasteless" -- not just a little bit tasteless, like the earlier discussion here about "dead cat bounce," but too tasteless.
Your thoughts? Comments? E-mail story tips to peter.viles@latimes.com.

Comments

[tew]

They'll probably succeed in turning a V into a U. That's about all they can do. In other words, they can smooth out and delay the nominal decline in prices and spread the decline over time while allowing inflation during that time to make the nominal bottom a bit higher than it would otherwise be.

So instead of really scary declines into '09 with a slow but steady ~inflation appreciation for years after that, we'll probably get a grinder through '09 with a flat market after that until around '11 and then slowly get back to tracking inflation.

At some point during this cycle (probably in '08/'09) we'll probably see a head fake (bear trap rally).

[smokey]

The rate cut might also spur inflation. And if what can drive the value of the dollar down even more; hey, who knows, in a year or two that 900 sq. ft. Craftsman might be worth $825K AGAIN!

Then we'll just hafta deal with the $10/gal milk, the $7/gal gas, and the $100K Toyotas.

Print It Ben.....Print It !!

[Mary C.]

But how will it work if there's far less money to lend? There are no longer large pools of money available for mortgages (i.e. securities), at least ones that don't conform to more conventional lending standards. That means the pool of buyers is still drastically reduced for still-overpriced real estate, especially at the entry and middle levels. Prices still need to fall greatly to align with incomes, even if lower interest rates do filter down (and reducing by one quarter when the Fed just slashed three-quarters ain't much). It's an impotent and anemic move that just delays the inevitable and hurts the economy in terms of lowering the dollar even more and penalizing savers.

[Paul Hiller]

Most of the rate cut was "baked in" as 1/2 point was widely expected, but not until the end of the month. The extra 1/4 drove t-bills down a bit. The immediate mortgage relief will be to helocs tied to prime. Adjustables are mostly tied to Libor which is not dropping in lockstep. The pay-option arms tied to the monthly treasury average will continue to trend down, but they fall slowly as they average the last 12 months. This will be of little real relief to the pay-option borrowers as most are making the minimum payment. For most borrowers from 05' it just means they will be a little less underwater.
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[Kaye Thomas]

Fixed rates are tied to bond rates. Discounts by the FED may ultimately affect bond rates because of how the market responds. The drop your reader may have "seen" was probably one that was already scheduled in anticipation of the FED dropping rates at their next scheduled meeting.

That said the drop in rates will affect adjustable rates and HELOCs. The hope is that by cutting rates the markets will respond favorably and will loosen up money making the cost of money for loans other then conforming fixed rate loans decrease.

That seems to be the theory.. but who knows. The FED has lowered rates over the last few months and rates for jumbo loans are still on the high side when compared to conforming loan rates as investors continue to be leery.

A reduction in rates would be beneficial for everyone. It certainly won't stop the number of foreclosures on properties in distressed areas but it may help homeowners who have equity and need to refinance...especially those in the higher priced areas like CA.

Lower rates are not going to turn this market back to 2004. Prices are not going to surge upward. However it may stave off a total plunge in the market nationally which is not a bad thing.

A recession is not the answer to the high home prices of the last few years. Recessions are not particular about who loses their jobs but generally it isn't the CEO of the company but the mid level manager or entry level workers who wind up out of work.

[Susan]

> Further, the dissenter points to this article in USA Today,

Not to mention this article in your own paper today:

http://www.latimes.com/business/la-fi-consumer23
jan23,0,3998854.story?coll=la-home-business

These declarative statements from "experts" about the financial world are starting to remind me of all the conflicting advice we get on the effects of drinking red wine!

[Al Ferrari]

Those aren't actually opposing opinions. They both reflect the idea that mortgage rates are heading lower.

As the economy worsens, the demand for long term bonds goes up, which means bond issuers can offer a lower interest rate. People offering mortgages also need to lower their rates to stay competitive with the yields offered by bonds. (After all, who would loan out money for a risky mortgage if you can make the same yield on a safe bond?)

[alvin]

seems to me that the "dissenting" evidence only supports diana olicks' commentary.

the fed cut 75, and what happens? well, it has no direct impact on long term rates, because, as diana correctly points out, those are fixed off the 10 year bond, not fed funds.

she said adjustable rates would be affected, but not as much as you might think - and sure enough, did rates at b of a go down the full 75 bips? no, according to the dissenter, they only went down 25, likely because the market was already pricing in a 50 bip cut.

as for how this affects prices - sure lower rates help at the margin. the problem is that a combination of tighter lending standards and a weakening economy likely more than offset any positive impact on the demand side, while those same negative impacts, plus too many people with mortgages they can't realistically pay back, aren't going to help the supply side anytime soon either. falling demand and rising supply = lower prices.

[Bubblewatcher]

As Diana Olick pointed out in that interview, the only thing that is really going to help resolve this crisis are lower prices. Now that lenders are actually looking at W2s and asking for downpayments, I'm afraid that Mr. & Mrs. Howmuchamonth appear to have left the buyer pool.