UrbanDigs: Mortgage Rates & Confidence / Banks Dont Let Rates Fall

Posted by urbandigs

Mon Aug 22nd, 2011 09:51 AM

A: Few things first. Number one, confidence always trumps lending rates. The data shows that record low mortgage rates are more of a boon to those seeking to refinance. Number two, make no mistake about it that rates are this low because uncertainty is rising and confidence is falling as our economy teeters on the verge of another recession - not the best combination for masses of new buyers to enter the marketplace. Add in a negative wealth effect as markets tend to fall hard when rates get so low and that may give new buyers some pause. So lets at least accept reality and take the good with the bad. Between 2005 and 2006, the peak of the housing markets, 30yr fixed mortgage rates were between 5.5% and 6.5%; and purchase volume was significantly higher as opposed to now with rates so much lower! With 30yr rates at historic lows today around 4.3%, most of the action is in refinancing, not new purchases. I want to quickly discuss why lending rates did not fall as much as Treasury rates over the past 4-6 weeks; where 10YR US Treasury yields declined over 100 basis points.

There are two main reasons why lending rates might diverge from trends in the US Treasury market in times of turbulence...

#1: Mortgage rates are priced off of mortgage bonds, not US Treasury yields, and are exposed to rising levels of credit risk. Higher credit risk, higher rate. Most of us use the 10YR US Treasury yield as an indication to where lending rates are trending, because not many of us out there have access to current pricing on mortgage bonds (you can check out US Govt Agency yields here). In normal times, yes, lending rates will have a relationship to trends in the 10YR Treasury market. However, in times of rising default risk expect a divergence.

#2: Banks can hold rates steady as Fees Rise and new Applications exceed capacity. This applies mostly to refinance applications when rates take a sharp move down. There seems to be fewer new purchase applications as a direct result of declining confidence as macro economic conditions deteriorate causing rates to fall in the first place.

Its item #2 that we have been seeing over the past 4-6 weeks resulting in much lower US Treasury yields, but not a synchronous fall in lending rates. A Streeteasy.com discussion starts out with a user stating:

"I'm set to close next week and the rate we locked in 1 month ago is high compared to what it is today (4.875). We've asked our broker to just let the lock expire so that we can lock in at current rates. She keeps telling us that HER rates haven't changed!"

Oh I believe it and wrote about it a week ago. While every buying situation is unique and exposed to different variables that may affect the lending rate, its the general awareness that lending rates did NOT fall as much as they should have considering the fall in Treasury yields that got this buyer upset. There are very real reasons, as discussed above, for why lending rates did not fall as far as some expected.

MortgageNewsDaily.com discusses, "Refinance Applications Surge on Lower Rates - Purchases Fall":

MBA's Market Composite Index, a measure of mortgage application volume, increased 4.1 percent on a seasonally adjusted basis from one week earlier. This follows a jump of 21.7 percent recorded in the previous week (see chart below).

The increases are being driven by refinancing which accounted for 78.8 percent of the market this week and 75.6 percent in the previous week. The refinancing share is the highest it has been since November 2010. "Unprecedented volatility in the stock market last week amid additional signs that the economy has slowed led to further drops in mortgage rates, with the 15-year rate reaching a new low for the MBA survey," said Mike Fratantoni, MBA's Vice President of Research and Economics. "Purchase application activity fell sharply over the previous week, likely the result of potential homebuyers hesitant to purchase in this highly volatile and uncertain environment."

Fratantoni continued, "Refinance application volume increased substantially for the week, although there was substantial variation across the market. In September MBA's Weekly Applications Survey will transition to an expanded sample that covers 75% of the retail market rather than the current sample that covers roughly 50% of the retail market. That expanded sample showed a significantly larger increase in refinance applications than the current sample, with some lenders reporting increases in refinance applications in excess of 50 percent for the week. The big differences in refinance volumes were likely driven by the decisions of some lenders not to drop rates last week, largely due to the need to manage their pipelines."

Its that last sentence that I wanted readers to see. A big reason why lending rates did not fall as far as Treasury yields was due to banks managing the substantial rise in refinancing applications (mostly refinancing requests) and managing their pipeline.

Record low rates should incentivize risk, and should incentivize buyers to take advantage. But it rarely works this way in housing markets due to the elements of 'confidence' and the 'wealth effect'. Rather, investors that are losing confidence in the broader economic picture tend to look at big investments as a potential depreciating asset in troubling times. So, they either wait it out or bid low and try to price in future downside risk. At the beginning of the cycle, sellers hold firm, reluctant to hit a lower bid unless their fear levels are high or forced under a time pressure to liquidate. This 'gap' between bid/ask can cause markets to experience plunging volume making the asset class itself very illiquid - this is exactly what happened to Manhattan in late 2008 into early 2009.

For 5 months between October 2008 and February 2009, we saw monthly new contracts volume below the 500 level (3 months under 360 level) as our market was exposed to plunging confidence, rising uncertainty and a severe negative wealth effect resulting in an absence of bids; see this chart below:

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Its all about the Bids and that period defined the Manhattan downturn! Looking back, many buyers wished they would have pulled the trigger at that point. But hindsight is 20/20 and if you put yourself back into time & place, fear was just too high to bid without future risks priced in. So the market shut down and when you need to sell something in an illiquid marketplace, a lower price is really your only option. That is how these things become cycles and if you think about it, this really is just one big credit/housing bust cycle that has been going on for years now. Consider this another ripple in the wave and record low rates are one side effect as the markets try to balance themselves to incentivize risk taking.

Source: http://www.urbandigs.com/2011/08/mortgage_rates_confidence_bank.html

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