Real Estate Market vs Mortgage Rates – Let the Battle Begin
On September 13, 2012, Ben Bernanke launched QE3. The Federal Reserve is going to buy $40 billion of agency MBS per month, or $9.12 billion per week.
During the 15 weeks since the QE3 announcement, ending Jan 2, 2013, the Fed has purchased $245.4 billion or an average of $16.36 bn. per week. In other words, the Fed is buying $7.24 billion more per week than announced. There are currently $927 billion of agency MBS on the Fed balance sheet. The $7.24 billion per week is the amount the Fed is re-investing as previous MBS are being prepaid. At this rate, the Fed will turn over about 40% of its portfolio this year.
If we use the average MBS purchases since QE3 began, the Fed is buying at a rate of $850.7 billion per annum. Let us put this number in the proper perspective:
1. According to the Mortgage Bankers Association, the US originated $1,712 billion of mortgages in the four quarters ending Sept 2012. At its current pace, the Fed is buying 49.7% of all originations.
2. According to Freddie Mac, for the first eleven months of 2012, 80% of the mortgage originations were refinances. This is a weighted average, so we can assume $1,270 billion of the originations were refinances and $342.4 billion were purchases. In other words, the Fed is purchasing 100% of all purchase mortgage originations plus 41.4% of the refinances.
3. Approximately 90% of originations are agency conforming and those are the only securities that Bernanke can buy. With this adjustment, the Fed is actually buying up a whopping 55% of all conforming originations.
4. There are about $9.5 trillion of total mortgages outstanding, with the Fed owning about 10% of all mortgages. As the non-conforming loans are prepaid, either voluntarily via a refinance or involuntarily via foreclosure, the Fed is going to own more and more as QE-infinity continues.
What is the expected outcome of this unprecedented recklessness? In theory, the Fed should be in total control of mortgage rates, since they are buying 50% of the market. However, if driving down rates is the goal, Bernanke has not been too successful thus far. The chart below shows rates have been flat since QE3 has begun and have reversed upward in the first few days of the new year.
Mortgage interest rates as of January 3
Similar to mortgage rates, the 10 yr treasury has not responded much to QE3 and QE4 until recently, when it started going up. If Bernanke wants to manipulate treasury rates, he may have to launch another QE to finance yet another $1 trillion of the federal budget deficit, just for this year. 'QE4' that has recently replaced Operation Twist is apparently not enough.
The 10 year treasury note yield. 'QE 3 and 4' are increasing inflation expectations, which proves to be a more powerful influence on rates for the moment than the purchases by the Fed.
The first signal is already here. According to the most recent Mortgage Bankers Association loan application survey for the two weeks ending December 28, 2012:
Mortgage applications for the week ending December 28, 2012 decreased 21.6 percent from the week ending December 14, 2012 (two weeks prior) ……………… The Refinance Index decreased 23.3 percent compared to the week ending December 14, 2012. The refinance index fell for three consecutive weeks, with the week ending December 28, 2012 at the lowest level since April 2012. The seasonally adjusted Purchase Index decreased 14.8 percent compared with levels reported two weeks ago.
There is no reason for anyone to refinance once rates are no longer going down. The only refinances left would be the HAMPs, HARPs and the procrastinators. It would not take long to flush them out of the system. The chart below is based on data from Freddie Mac. At over 80%, the percentage of refinances is not only at record high, it has been this high for the last four years. By how much will refinance applications drop this time, 20%, 30%, 50%, more? Look at what happened in 1999, at the end of the technology bubble. When rates increased from the 7% range to over 8%, refinance activity plummeted. I think if mortgage rates were to rise above 4%, refinance activity may vanish completely.
Refi percentage versus mortgage rates
We know rates cannot go down forever. Is this the beginning of trend reversal or is Bernanke going to throw in a few more kitchen sinks before throwing in the towel? Am I the only one who thinks that Bernanke has exhausted his bag of tricks? What can he possibly do to drive rates lower, if that is his desire?
There are two ways to drive rate lower. Firstly, Bernanke can up his bid and buy whatever is needed to keep interest rates at his target level. This should not cost much more since Bernanke is already buying approximately half the market. Another trillion or so and Bernanke can own the entire market. Secondly, Bernanke can hope that if the volume of refinancing applications decreases, the originators will voluntarily reduce their profit margins. That obviously would only have a limited effect. Lenders are certainly not going to originate loans at a loss.
It is not too early to contemplate what real estate conditions would be like if rates were no longer declining.
Without the refinance business, what would happen to the lenders such as Wells Fargo which have been living off the Bernanke gift?
Even without mortgage equity withdrawal, refinances have typically reduced mortgage payments, contributing to household cash flow. To what degree will the economy be affected when the music stops?
The housing bulls have always claimed that there are millions upon millions of well qualified buyers on the sidelines, even though they are unjustly denied mortgages due to unreasonably stringent underwriting practices. How many qualified buyers are really there, waiting to jump in on this recovery?
If rates were to go up, home prices would have to offset a higher mortgage payment. Is the market strong enough to absorb that added cost?
Real Estate Market vs Mortgage Rates – Let the Battle Begin.
Charts by: StockCharts, Freddie Mac
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