Fixed mortgage rates decrease to lowest level in eight months

Fixed mortgage rates have fallen to their lowest levels since spring, as investors become confident that the Federal Reserve will cut short-term interest rates.

The benchmark 30-year fixed-rate mortgage fell 12 basis points to 6.17 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.36 discount and origination points. One year ago, the mortgage index was 6.17 percent; four weeks ago, it was 6.29 percent.

The benchmark 15-year fixed-rate mortgage fell 7 basis points to 5.85 percent. Reflecting investors' concerns about risk, rates went up on hybrid adjustables and jumbo loans.

The benchmark 5/1 adjustable-rate mortgage rose 6 basis points to 6.21 percent, and the 30-year fixed-rate jumbo mortgage rose 4 basis points, to 7.24 percent. A jumbo is a mortgage for more than $417,000. Typically, jumbo rates have been about a quarter-point higher than rates for smaller loans ("conforming" mortgages). Now, because of concerns about credit quality, they're more than a percentage point higher.

The 30-year fixed hasn't been this low since the middle of March, when it dipped to 6.16 percent. Other than that week, this is the lowest it's been this year. It was lower for two weeks last December, too.

Fed expectations

It is plain that bond investors think the Fed will reduce the federal funds rate, probably more than once, because of where the yield on the 10-year Treasury has moved. It's about half a percentage point lower than the federal funds rate, which is set by the Federal Reserve.

Generally, you expect shorter-term interest rates to be lower than longer-term rates. That's not what's happening with the federal funds rate and the 10-year Treasury. The federal funds rate is what banks charge one another for overnight loans; the yield on the 10-year Treasury essentially is the rate on a long-term loan to the federal government. The overnight rate is about half a percentage point higher than the 10-year rate, when normally it would be lower. This is an indication that bond traders expect the Fed to cut the federal funds rate by at least half a percentage point within the next few months.

Fed officials recognize this. According to the minutes, at each meeting of the rate-setting committee, the panelists discuss market expectations and investor reactions to Fed rate policy. And the central bank usually trots out a banker or two, in advance of a meeting, to set up market expectations.

That happened Wednesday, when Donald Kohn, the Fed's vice chairman, spoke to the Council on Foreign Relations in New York. What reporters call the "nut graf" of the speech went like this: "As the Federal Open Market Committee noted at its last meeting, uncertainties about the economic outlook are unusually high right now. In my view, these uncertainties require flexible and pragmatic policymaking -- nimble is the adjective I used a few weeks ago."

That was taken as a signal that the Fed will take the hint and give the market the rate cut it wants. Kohn talked like a father who gives his teenager a cell phone and explains that he's doing it so the kid will have a phone in case of emergency, when both father and child know that it's to stop the kid from whining about not having a cell phone. In this case, Kohn took pains to stress that any rate cuts will be made "to foster price stability and maximum sustainable growth and to restore better functioning of financial markets," and not to prop up the housing market.

Housing falling down

Housing is in bad shape. According to the National Association of Realtors, existing-home sales fell 21 percent in October compared with the previous October, to a seasonally adjusted annual rate of 4.97 million units. The median home price fell 5 percent compared to a year earlier. Foreclosure rates are rising because troubled homeowners can't refinance their mortgages or sell because they owe more than their homes are worth.

Bob Walters, chief economist for Quicken Loans, says the Fed is in a tough spot, needing to lower rates to keep financial markets running but without being perceived as rewarding risky behavior.

"They know in the longer run this'll work itself out, but in the shorter run, it can become a painful thing," Walters says.

In his speech Wednesday, Kohn said the Fed definitely wants to avoid rewarding stupidity. It doesn't want to bail out homeowners who bought houses they couldn't afford or the lenders who gave them the money to do it. If the Fed helped out those homeowners and lenders, then people would expect similar bailouts in the future, he said. There would be insufficient punishment for making dumb decisions. But ...

"To be sure, lowering interest rates to keep the economy on an even keel when adverse financial market developments occur will reduce the penalty incurred by some people who exercised poor judgment," Kohn said. "But these people are still bearing the costs of their decisions and we should not hold the economy hostage to teach a small segment of the population a lesson."

Whatever the Fed does, someone will interpret it as a lesson. Whether it's the lesson that the Fed wants to convey is another matter.