FED Rate Cut....Guilt By Association

Many people associate a FED interest rate cut with automatically lower interest rates in mortgages this is a misconception. The interest rates on conforming mortgage products are determined by the the underlying bonds and their yeilds. The best gauge the public has to really track the directionality of mortgage interest rates comes from the 10 year BOND yield.

75 Basis Point Rate Cut So What...

This week the FED stunned with a 75 basis rate cut but does that really change things? No not really, what is happening here in our housing market is so much larger than the average citizen and most savvy analysis have manage to grasp. Imagine that our housing downturn can have a global impact on all banks in all countries. That in itself should raise so many questions as to how this could really be possible and what it will take to stop it. The emergency rate cut really amounts to a pebble getting in the way of a run away bus down a mountain. What the FED put in motion with its rate hikes and rapid escalation of the LIBOR INDEX and subsequent increasing defaults in adjustable rate mortgages in both Subprime and Prime markets has cause a chain reaction of events that cannot be turned off overnight. Most Americans do not understand how adjustables work here it is in a nutshell. Your teaser rate will adjust based on 2 things; a banks margin + an index....In the case of most adjustables that would be the LIBOR INDEX, then there is COSI and COFI and MTA which are all relatively correlated in the same fashion to the FED Funds rate. When the FED moves the FED rate up it also increase the the index that will determine where your adjust can adjust which will be a higher rate. Higher rates mean higher rate of default unless you income is adjusting to your mortgage payment which it is not. In a nutshell the FED giving us higher rates means they are giving Americans higher payments on various forms of debt mortgages credit cards and lines of credit.

Subprime is not the disease but merely the symptom of an epidemic that has now infected all markets everywhere. Put it this way, when rates where at 1.25% if the FED went on television and told Americans they think there going to go ahead and raise rates 4% to 5.25% during your housing boom people would have been up in arms about such a proposition. The bottom line is the default rate in adjustable rate mortgages increased lock step with the rate hikes until it put in motion these downwardly cascading home prices which removed the equity in homes necessary to refinance out of teaser rates while teaser rates where now adjusting more aggressively due to the rate hikes. In effect trapping other home owners in there homes strapped to a chair just watching the clock on the adjustable time bomb countdown to zero with no escape..The rate hikes where the kindling for this bonfire and now they are trying to put it out with squirt guns.

The fact of the matter is the the foreclosure surge has a created reduction in home equity, an increase in LTV/Risk to lenders, destruction of the Subprime and ALT-A markets, a reduction of mortgage products to service a market that grew based on there availability, a surge in home inventory, and compromised the entire credit markets liquidity globally. If you can turn that off with a 75 basis cut I'm a monkey's uncle....and I'm not.

Interest Rates

3 Month LIBOR

3 Month CMT

Federal Funds

The LIBOR Index, which is the index that controls the adjustment of most all adjustable rate mortgages and thusly a direct contributer to the rampant foreclosure problem, is depicted here.

Note the correlation to the Fed Funds Rate.

Did our own Central bank knowingly sabotage our raging housing market. 17 consecutive rate hikes in a massive debt boom what would you expect to happen. The escalation of the LIBOR Index which now is forcing very high adjustments to teaser rates on adjustable rate mortgages did not happen by itself. Now the FED is here to save the day with rate cuts if the market needs it. What!?! Does anyone want to ask them why they cranked it up in the first place and are now trying to play hero to a problem it appears they were in direct control of creating? Your thoughts....