...Okay folks, get ready for a long one, but hopefully worth the read! :) I want my Four Point Five, interest rate that is… That’s right, we’re all sitting around waiting for that 4.5% interest rate that the Feds promised. After all, it’s the only thing that will get our economy turned around right?
Well, that and the new pork belly stimulus package, but that’s a different subject all together.
We’re here today to try and understand why interest rates haven’t dropped to 4.5% like the Fed promised. The answer is in something called the Mortgage Backed Securities (MBS) market and the Treasury Bond (TSY) market.
I wish the explanation of how these markets work was simple but it’s not so I’ll try to summarize using visual analogies.
Imagine a table covered with stacks of little square crackers. All the crackers look the same but their not. Some have a little salt on them, some have no salt on them and some, well, they have a whole lot of salt on them.
Now imagine that you live on a diet of crackers and salt. Sometimes you need more salt and sometimes you need less, BUT! you always need crackers. On days when you need a lot of salt and you have to compete with others that need the salt too, you’ll pay more for the very salty stack of crackers and pay less for the unsalted stack.
Supply and demand comes into affect. There is a limited supply of stacks of very salty crackers and everybody wants them, this drives the price of the very salty cracker stacks way up!
This is what is supposed to happen in the MBS (Mortgage Backed Securities) market. There are pools of securities called Stacks. A share of a stack, one cracker if you will, starts out worth $100.
These stacks come with different layers of salt or interest rates. So you’ve got a stack that pays a 4% rate, 4.25% rate, 4.5% rate, 5% rate and so it goes. Because of the varying returns on each of these stacks, the price of the share (the cracker) in the stack will vary based on the number of buyers for that stack.
So, if nobody wants a 4% return, the $100 share might be sold for $98. If everybody wants a 5% return then a cracker …uhumm, I mean share, in that stack might sell for $102 dollars. Why is this important?
Well, it’s important because these interest rates represent a yield to the owner and that yield affects the interest rates that you and I pay on a long-term mortgage. Get the picture?
Well, that and the new pork belly stimulus package, but that’s a different subject all together.
We’re here today to try and understand why interest rates haven’t dropped to 4.5% like the Fed promised. The answer is in something called the Mortgage Backed Securities (MBS) market and the Treasury Bond (TSY) market.
I wish the explanation of how these markets work was simple but it’s not so I’ll try to summarize using visual analogies.
Imagine a table covered with stacks of little square crackers. All the crackers look the same but their not. Some have a little salt on them, some have no salt on them and some, well, they have a whole lot of salt on them.
Now imagine that you live on a diet of crackers and salt. Sometimes you need more salt and sometimes you need less, BUT! you always need crackers. On days when you need a lot of salt and you have to compete with others that need the salt too, you’ll pay more for the very salty stack of crackers and pay less for the unsalted stack.
Supply and demand comes into affect. There is a limited supply of stacks of very salty crackers and everybody wants them, this drives the price of the very salty cracker stacks way up!
This is what is supposed to happen in the MBS (Mortgage Backed Securities) market. There are pools of securities called Stacks. A share of a stack, one cracker if you will, starts out worth $100.
These stacks come with different layers of salt or interest rates. So you’ve got a stack that pays a 4% rate, 4.25% rate, 4.5% rate, 5% rate and so it goes. Because of the varying returns on each of these stacks, the price of the share (the cracker) in the stack will vary based on the number of buyers for that stack.
So, if nobody wants a 4% return, the $100 share might be sold for $98. If everybody wants a 5% return then a cracker …uhumm, I mean share, in that stack might sell for $102 dollars. Why is this important?
Well, it’s important because these interest rates represent a yield to the owner and that yield affects the interest rates that you and I pay on a long-term mortgage. Get the picture?
The higher the price above $100, the lower the actual yield or return to the owner is. When the price of the shares in the stack increases the yield decreases and the net result is lower interest rates. In simplified terms this is the way the MBS market works and it is how banks determine the interest rates we pay on our loans.
Now, on to the problem at hand! Why aren’t rates going down? Rates are not decreasing because everybody has figured out the game. In order to make rates go down, the Fed has to buy up stacks of Mortgage Backed Securities.
In order to fund these purchase the Fed did two things. They sold Treasury Notes (TSY) and they printed money. When this happened ‘the jig was up’ on many levels.
First, foreign governments saw us diluting our dollar and flooding the bond market so they stopped buying our debt. Big problem! This caused the price of TSY to drop and the yield to increase, it also caused the Fed to have less buying power.
Second, many banks spied an opportunity! If they could get some extra stacks out in the market, maybe the Fed would buy them and pay a premium. Bonus time, right?! Not so much.
What ultimately happened was the ‘Market’ (that’s right, with a big M) figured out what was going on. The MBS market was flooded with stacks. Everybody want a piece of the Feds action. i.e. all the banks wanted some more of our tax dollars, like the bailout funds weren’t enough!
When these stacks flooded the market the Fed could not absorb them all and the price on the stacks dropped sharply. This increased the yield and ultimately increased the interest rates we are offered on mortgages!
Now the markets are starting to settle again and the overload of stacks is being slowly absorbed. Here's the $64,000 question, when will rates dip below 5% again?
I’m not sure, but my guess is as soon as the government stops tinkering with it all. If they would just let the markets work, rates would have come down naturally. Every time the Fed does something like this it seems to put us 30 days farther out.
I want my 4.5 and I know you want yours too. My suggestion is to get out there, choose a lender and get approved and then be patient and wait for the rate that is right for you. When you see it, grab it! Chances are it won’t be there for long….
Michael Gross is the President of Dividend America Mortgage and has been in real estate for over 20 years. He has been a builder, a Realtor, an appraiser, and currently he is a lender and an active real estate investor. He uses all of his experience and knowledge to show individuals how to properly use a mortgage as a tool to help create greater wealth through real estate investing. For more information on residential and small commercial loans please call 770-350-7373 or email mgross@dividendamerica.com
Now, on to the problem at hand! Why aren’t rates going down? Rates are not decreasing because everybody has figured out the game. In order to make rates go down, the Fed has to buy up stacks of Mortgage Backed Securities.
In order to fund these purchase the Fed did two things. They sold Treasury Notes (TSY) and they printed money. When this happened ‘the jig was up’ on many levels.
First, foreign governments saw us diluting our dollar and flooding the bond market so they stopped buying our debt. Big problem! This caused the price of TSY to drop and the yield to increase, it also caused the Fed to have less buying power.
Second, many banks spied an opportunity! If they could get some extra stacks out in the market, maybe the Fed would buy them and pay a premium. Bonus time, right?! Not so much.
What ultimately happened was the ‘Market’ (that’s right, with a big M) figured out what was going on. The MBS market was flooded with stacks. Everybody want a piece of the Feds action. i.e. all the banks wanted some more of our tax dollars, like the bailout funds weren’t enough!
When these stacks flooded the market the Fed could not absorb them all and the price on the stacks dropped sharply. This increased the yield and ultimately increased the interest rates we are offered on mortgages!
Now the markets are starting to settle again and the overload of stacks is being slowly absorbed. Here's the $64,000 question, when will rates dip below 5% again?
I’m not sure, but my guess is as soon as the government stops tinkering with it all. If they would just let the markets work, rates would have come down naturally. Every time the Fed does something like this it seems to put us 30 days farther out.
I want my 4.5 and I know you want yours too. My suggestion is to get out there, choose a lender and get approved and then be patient and wait for the rate that is right for you. When you see it, grab it! Chances are it won’t be there for long….
Michael Gross is the President of Dividend America Mortgage and has been in real estate for over 20 years. He has been a builder, a Realtor, an appraiser, and currently he is a lender and an active real estate investor. He uses all of his experience and knowledge to show individuals how to properly use a mortgage as a tool to help create greater wealth through real estate investing. For more information on residential and small commercial loans please call 770-350-7373 or email mgross@dividendamerica.com
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