Treasury Plan Pushing up Mortgage Rates

As the Treasury bailout plan opens the faucets to thaw credit markets, and maybe even jumpstart the overall economy, affordable housing is slipping away due to rising-not falling-mortgage rates.

In the middle of October, 30-year mortgage rates jumped.  This happened despite the bailout, and the fact that the central bank slashed interest rates by a huge half point to help banks with liquidity, and bail out homeowners facing foreclosure by offering them some affordable housing refinance opportunities. Dropping rates a half point is always interpreted as a drastic move from the Fed, but this was even more powerful and profound.

Cutting rates from 2 percent to 1.5 percent is, after all, not just a half point lower, but a 25 percent discount.  If rates were at 10 percent, for instance, a half-point drop would leave them at 9.5, which is only a 5 percent cut. A 25 percent cut from 10 percent, for example, would send rates plummeting down to 7.5 percent.

What this all means, in other words, is that we're at a level so low, that any changes in rates are magnified in their significance, and should translate into a huge change in mortgage rates.

Mortgage rates not reacting normally

A 25 percent lowering by the Fed would normally send mortgage rates into the basement. But these are not normal economic times.  Instead, mortgage rates spiked more than 50 basis points in the week following the Fed's drastic move-the exact opposite of what they traditionally do.

In this situation, 30-year mortgage rates climbed to an eight-week high, averaging 6.46 percent.  This was up from 5.94 percent in the preceding week, the largest single weekly rise in fixed mortgage rates since 1987. To put that into a rather disturbing perspective, consider the fact that just 12 months ago, 30-year mortgage rates averaged 6.40 percent. But that was months before the Fed even hinted at the beginning of its historically aggressive policy of cutting rates as a way to bail out the collapsing housing and lending markets.

Low rates to come?

Based on traditional math, Americans should now be enjoying the lowest mortgage rates in history, with consumers gobbling up affordable housing like it was going out of style. The harsh fact is that affordable housing and low interest rates have actually gone out of style, at least for the foreseeable future. We're living in a topsy-turvy world, where the way that markets behaved before is now, unfortunately, completely obsolete.

The most optimistic scenario is that the bailout plan will buy toxic mortgages, freeing banks to lend while also putting a stop to foreclosures. That will inspire buyers while there are still affordable housing prices.  If lenders offer loans at mortgage rates corresponding with Fed rates, we'll definitely be on the road to recovery.