Lately, our US economy has needed stimulation to return closer to the equilibrium point of enough money via taxation to enjoy full employment, limited inflation, and adequate tax revenues to run the government.
The Federal Reserve Bankers (“The Fed”) buy/hold US treasury bonds/securities when they desire to stimulate the economy, and sell those same treasuries/bonds when they want to slow the economy and rein in inflation.
- They do this on the open market, just like you and I (competing with retirement funds, mutual funds, foreign governments, insurance companies, etc.).
- However, The Fed – with its enormous capacity – relatively predictably affects the supply and demand balance of how many buyers/sellers are available, and at what price those buyers/sellers trade their securities.
In a supply and demand market…
- If there are more purchasers relative to the supply of an item (whatever it is –cars, salaries, food, US treasuries) the price of that item typically moves up (or the availability of that item dries up).
- If there are more sellers than buyers for that item, it drives the price down.
- Think of our pricing in a market economy as an ongoing auction, whether it’s called an auction, or not.
- It is in this context that “The Fed’s” actions play out…..
Since treasuries/bonds (mortgages are bonds) pay a fixed amount of money every year (known as a “coupon), there is an inverse relationship between current market rates and the price of existing bonds.
If the fact of a bond price going up makes rates go down seems backward to you, please let me use an example to explain:
- Say that a bond pays $5/year. This will not change.
- If bond investors require a 5% return (yield) on their money, they would pay $100 per $5 of annual coupon for this bond on the day that the bond is created.
- $100 * 5% = $5.
- But, let’s say that later, the same bondholder wants to sell that same bond.
- If the investors at that later sale date require a 6% return, they would pay $5/.06= $83.33 for that bond.
- Conversely, if investors require only a 4% return, they would pay $5/.04 = $125 for the same $5 per year.
- For detail-obsessed technocrats (I am one), there are more inflective details to this (maturity date, etc.), but this information is close, complete and correct enough to be actionable considering the context of creation of new mortgages for new transactions.
- The Fed usually can do all it needs in the US economy by buying and selling ONLY US treasuries. But, The Fed can affect all kinds of financing cost and availability by buying/selling in those markets as it has lately: mortgages, corporate bonds, etc.
Why did the GOVERNMENT need to act? Why not the US “free market” economy?
- At the depths of the recession, there were not enough private investors to accomplish the government’s priorities of full employment, limited inflation, and adequate tax revenues.
- So, the government acted on its own plus theoretically the interests of the public that employs in its ability to take more risk using our public money (both debt and tax derived) than private investors were willing or able to do.
Now that the economy is growing again, risk to private investors/lenders is reducing, and private investors/banks are stepping back in at more reasonable rates for the risk of investing their money.
As the US economy/government/Fed pursues the desired “privately funded equilibrium” of priorities initially mentioned (full employment, limited inflation, and adequate tax revenues), and as long as sufficient private investors participate, the government will try to carefully extricate itself by first reducing the amount of stimulus (yesterday’s announcement reduced purchases from $85 billion to $75 billion per month), and later selling its bond assets back in the economy. This may take years to accomplish.
What does this new shift from public to private funding mean for housing and housing finance?
- Since the economy is recovering, we are employing more people:
- There are and will be more workers with more money to buy more houses.
- Prices should go up.
- Because private investors require higher returns over inflation than the government requires:
- Higher rates for mortgages.
- Price increases may be dampened.
- Since the labor pool is tightening and wages are anticipated to increase, buyers will afford higher payments and prices, therefore more houses will be sold, and higher prices can be paid.
- Mortgage rates will go up.
- Housing prices will go up.
- Homeownership will go up.
- American workers will have more money to pay for housing – and that ability will more than offset the costs of higher interest rates.
Scott Layden is Senior Mortgage Planner and originator for Benchmark Home Loans in Franklin, TN. Scott Layden specializes in “obtaining the lowest net after-tax cost of mortgage borrowing for the time period a client will have the money, offset and with respect to their short and long term financial needs and priorities.” You can reach the Scott Layden Team at 615-224-8851.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Ark-La-Tex Financial Services, LLC d/b/a Benchmark Mortgage 5160 Tennyson Pkwy STE 2000W, Plano, TX 75024. NMLS ID #2143 (www.benchmark.us) 972-398-7676. This advertisement is for general information purposes only. Some products may not be available in all licensed locations. Information, rates, and pricing are subject to change without prior notice at the sole discretion of Ark-La-Tex Financial Services, LLC. All loan programs subject to borrowers meeting appropriate underwriting conditions. This is not a commitment to lend. Other restrictions may apply.