The Games Mortgage Rates Play


Over the past six months, we saw mortgage rates drop to previously unimaginable levels. At the end of November, for instance, the average rate on a 30-year conventional mortgage was 3.31%. Think about that for a second. Once you factor in inflation, which is admittedly still too low, the real rate drops below 2%. That's shocking!

At the same time, however, new-home sales, while improving, were nothing near the levels that one would have expected, given the supply of free -- or as close to free as we'll ever see -- money. Yes, they're improving, but with interest rates like these, one could have reasonably expected them to be exploding higher.

Are mortgages being underwritten? Absolutely. Since the second quarter of 2011, they've shot up by 43% at the nation's five largest lenders. Wells Fargo and US Bancorp provide prescient examples of this. In the first quarter of 2011, Wells Fargo originated $84 billion in mortgages; by the first quarter of this year, that figure grew to $109 billion. Over the same time period, US Bancorp's numbers grew from $12 billion to $22 billion.

So what gives?

While you may have already guessed why dramatically higher mortgage-origination volumes haven't spurred the housing market more robustly, it wasn't until yesterday that I got my hands on data that demonstrates it quantitatively. As you can see in the chart below, the answer is that the vast majority of mortgages being underwritten relate to refinancing previous mortgages, as opposed to so-called "purchase-money" mortgages.

With this in mind, any fear that an impending drawback of Federal Reserve support -- which has roiled markets over the last few days -- will significantly impair the housing market, and homebuilding in particular, is probably overblown.

Does that mean the markets have over-reacted over the last few days? Yesterday, for instance, the Dow Jones Industrial Average fell by more than 300 points -- the worst single-day drop this year. And, as my colleague Matt Thalman pointed out, it was the eighth consecutive day of triple-digit moves by the blue-chip index.

The answer is: maybe yes and maybe no. While the central bank's easy-money policies have yet to ignite a more robust housing recovery, they've certainly fueled inflation of equity prices. As fellow Fool Alex Dumortier put it yesterday, "If anyone had any doubt that this year's rally was partially (or, perhaps, even heavily) fueled by the market's happy hope of eternal Fed liquidity, the market's reaction to Ben Bernanke's announcement on Wednesday afternoon that the central bank expects to slow its bond buying this year should erase any and all of them."

In my opinion, all of the market noise is nevertheless much ado about nothing -- but I could be wrong. In 1937, for instance, the Fed raised short-term interest rates prematurely, thereby plunging the economy back into depression. But, for reasons I won't get into here, the analogies aren't as strong as they might appear on the surface. Therefore I simply urge readers to eschew the practice of incessantly checking their brokerage accounts until things calm back down again.

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