Are Low Mortgage Rates Here to Stay?

Immediately following the Treasury takeover of Fannie Mae and Freddie Mac, borrowers took advantage of much lower mortgage rates, and refinance applications surged. But with extreme financial uncertainty in the U.S., mortgage rates are poised to rise again before too long.

Before the emergency Treasury Department takeover of Fannie Mae and Freddie Mac, mortgage rates were trending higher. As a result of the Treasury action, however, mortgage rates plunged. Rates on 30-year fixed-rate mortgages fell by the largest one-week drop in almost 30 years, and loan applications spiked as mortgage rates hit a four month low.

But low rates are probably not sustainable. Just as the credit score of a consumer shrinks as his debt grows, greater responsibility for saving ailing institutions hurts the reputation of the Treasury. The ongoing demise and bailout of other important financial institutions, in addition to Fannie Mae and Freddie Mac, reduces the quality and marketability of its monetary instruments as investor confidence in the Treasury erodes.

Treasury to the rescue

After bailing out Fannie Mae and Freddie Mac, for instance, Treasury Secretary Paulson decided that it was critical to our economy to rescue AIG, the largest insurance company in the history of the world. AIG has a trillion dollars in assets, but those will take time to liquidate. In the meantime, the Treasury needs to issue more debt instruments-such as Treasury bonds-to raise the cash required to fund the $85 billion AIG bailout.  If investors don't buy those bonds, but choose instead to aggressively sell Treasury products, the value of instruments like the 10-year Treasury note will plummet.  This will send their corresponding interest rates sharply higher in an effort to lure buyers back. Mortgage rates typically follow the lead of 10-year Treasury notes, so the more the Treasury assumes the rescue role, the more upward pressure will be placed on retail mortgage rates.

Mortgage rate pressure

The chances of that happening are growing, because the Treasury may have to help other institutions or buy up tons of bad loans to get them off the market and stabilize our economy.

 Here's why:

• American companies own approximately $22 trillion in risky financial instruments such as "securitized" mortgages.
• Because of a lack of government oversight, the whereabouts of this high-risk debt is nearly impossible to track.
• Many of these investments are now worthless, because the market for them has been completely wiped out.
• Which companies own these bad assets, and how long it will take before the worthless investments undermine their profits and leave them bankrupt, remains a mystery.

Until the Treasury gets some concrete answers to that $22 trillion question, and a more precise understanding of how it can remedy the situation even as the economy gets weaker, expect to pay higher mortgage rates. Those hoping to snag lower rates in the aftermath of the Fannie Mae and Freddie Mac takeover better hurry and do it while they're still available.