The Federal Reserve is going to extraordinary lengths to push down long-term interest rates, including home-mortgage rates. But those hoping mortgage rates will fall sharply from current levels, already historically low, may be disappointed.
Mortgage firms Thursday were quoting rates averaging 4.75% on 30-year fixed-rate mortgages, according to Zillow.com, a real-estate information service. That is down from more than 5% two days ago and about 6% in mid-November. But further big declines will be hard to achieve, partly because the mortgage-lending market has grown less competitive in the past year as hundreds of small banks and independent mortgage lenders have collapsed. The big banks that dominate the market are eager to boost their profits margins, not give deeper bargains to consumers.
Rates for borrowers with the strongest credit are likely to be in a range of roughly 4.5% to 4.75% for the rest of this year, says Mahesh Swaminathan, a mortgage strategist at Credit Suisse in New York.
Others say that is too optimistic. Assuming no big change in government policy, Walter Schmidt, an analyst at FTN Financial Capital Markets, sees a range of 4.75% to 5.5% for most of this year.
The Fed began driving mortgage rates down in late November when it announced plans to buy as much as $500 billion of mortgage securities this year. On Wednesday, the Fed expanded that program, saying it will spend as much as $1.25 trillion on such securities in 2009. That is enough to provide funding for more than half of all home-mortgage loans likely to be made in the U.S. this year.
The Fed also is buying long-term Treasury bonds to drive down rates on those securities, whose pricing affects mortgage rates.
By historical standards, rates look incredibly low. Until recently, 30-year fixed-rate mortgages hadn't been below 5% since the 1950s. For the past couple of months, rates have been bobbing between about 5% and 5.25%. The 30-year rate averaged 4.98% in the week ended March 19, down from 5.03% the prior week, according to Freddie Mac's survey. Fifteen-year fixed-rate mortgages averaged 4.61%, down from 4.64%.
One reason mortgage rates often tick back up after a decline is that a rush of people seeking to refinance quickly causes backlogs at lenders, which frequently don't have enough employees to process all of the applications.
"If lenders are working people overtime to close loans, they don't have an incentive to compete too hard on price," says Arthur Frank, who heads research on mortgage securities at Deutsche Bank in New York.
The situation highlights a conundrum for the government. It wants low rates to spur the housing market, but also wants the banks to make profits on loans so they can return to financial health.
Many of the small mortgage banks that remain are struggling. Mortgage banks, often small, family-owned companies, aren't licensed to take deposits and so lack that source of money for their loans. Instead, they typically borrow money for short periods from so-called warehouse lenders. They use this short-term credit to make loans to their customers and then pay back the warehouse lenders after selling the loans to bigger banks or to government-backed mortgage investors Fannie Mae and Freddie Mac.
But this warehouse credit is much harder to obtain than it was a year or two ago because many of the big banks and Wall Street firms that used to provide it have exited that business.
Despite these constraints, the Fed's action is "going to be a plus" for the housing market, says Thomas Lawler, an economist in Leesburg, Va. Lower rates make it more likely that home prices will hit bottom in many parts of the country later this year, Mr. Lawler says. The recovery, though, is likely to be gradual, partly because rising unemployment reduces housing demand.
Christopher J. Mayer, a real-estate professor at Columbia Business School in New York, says the Fed's moves to cut rates are "helping to put a floor under the housing market." But he worries that the Fed could face huge losses on the mortgage securities if inflation fears eventually push interest rates much higher.
Still, the consumers who need these low rates the most aren't likely to get much help. Many people can't qualify for these low rates because their credit scores aren't high enough or they can't afford a down payment of 20% or more on a home purchase. Such people will be socked with fees that can drive up their housing costs considerably. Banks also have become far pickier about appraisals and are nixing many purchases as a result.
Others can't qualify for a refinancing because they owe far more on their homes than the estimated current market values. Fannie Mae and Freddie Mac have new refinancing programs that will let some borrowers refinance into lower rates even if they owe as much as 105% of the home value, but only for current loans owned or guaranteed by Fannie or Freddie.
Write to James R. Hagerty at bob.hagerty@wsj.com
The difference between a recession and a depression.
During his 1980 Labor Day speech at New Jersey's Liberty State Park, Republican presidential nominee Ronald Reagan listed the economic failures of his opponent, President Jimmy Carter. With the Statue of Liberty as a backdrop, Reagan used the moment to respond to Carter, who had accused Reagan of misusing the term "depression" to describe a recession that began in January of that year. "Let it show on the record that when the American people cried out for economic help, Jimmy Carter took refuge behind a dictionary. Well, if it's a definition he wants, I'll give him one. A recession is when your neighbor loses his job. A depression is when you lose yours. And recovery is when Jimmy Carter loses his."
However imprecise Reagan's macroeconomic definitions may have been, he'd made his point. Semantics don't mean much to Americans who have lost or are about to lose their jobs, their savings and their homes. But for those charged with charting the fastest course to an economic recovery, knowing the exact severity of the situation is critical. So what does constitute a recession, or a depression? Answering that question is harder—and takes longer—than you might expect.
Some economists define a recession as two consecutive quarters of economic contraction, or a decline in real gross domestic product (GDP). By that measure, the U.S. wasn't off to a bad start this year. According to the Bureau of Economic Analysis, real U.S. GDP rose 0.9 percent in the first quarter of 2008 and 2.8 percent in the second quarter. The problem with such a simple definition, according to James Poterba, president of the National Bureau of Economic Research (NBER), the official arbiter of when recessions begin and end, is that it "omits the possibility that you see two very tiny declines in two quarters, and [it also] doesn't look at other information for the rest of the economy, which may suggest that what is happening is not a broad decline."
According to NBER's definition, a recession occurs when a "significant decline in economic activity is spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales." The beginning of a recession is commonly referred to as a business-cycle "peak," and the end of it is called a business-cycle "trough."
Robert Gordon, a member of the NBER committee responsible for determining the beginning and end dates of recessions, says making a determination is often complicated by the fact that figures like GDP can be revised substantially even years later. Roy Smith, a professor at NYU's Stern School of Business, adds, "It's very frustrating for commentators and other folks who feel like they know in their gut that we are in a recession, but that is not a very scientific [approach,] so people can get it wrong. The choice is that someone calls it based on their gut, or we wait for the data."
Waiting for the data tends to take some time. As a result, most recessions have not been declared by NBER until at least five months after they've ended. The one marker that seems to be a constant in most recessions is unemployment. "There has never, in the postwar U.S., been a 1 percentage point increase in unemployment without a recession having been declared, and much of that increase in unemployment occurs after the recession started," says Gordon. "Right now, we've had a 1.7 percent increase in unemployment. On historical precedence, absolutely this is a recession. All we have to do is figure out when it began."
Still, to NBER, the means by which to measure a recession make as much sense today as they did 50 years ago. Harvey Pitt, former chairman of the Securities and Exchange Commission and CEO of the global consulting firm Kalorama Partners, says there is another reason why the process by which a recession is defined will likely go unchanged. "It's fairly elastic, because it has enormous economic as well as political consequences," he says. "Whoever is running the government at any particular time wants to avoid people drawing the conclusion that economic stagnation is a recession."
When it comes to depressions, Pitt believes the term is fairly well understood, even if there is no official definition. A common unofficial definition for a depression refers to a deeper and prolonged recession during which the GDP declines by more than 10 percentage points. That was certainly the case in the 1930s, when the GDP dropped by more than 30 percent from 1929-33, with unemployment rates peaking at 25 percent in 1933. "These numbers were monstrously larger than anything we'd experienced otherwise," says Smith. "We have no other modern experience of it and will likely not have any, because we've installed safeguards that didn't exist then to prevent such a catastrophe."
Smith doubts there's a need for an official definition, because he believes it is unlikely that the country will find itself in such a drastic situation again. The NBER's Gordon says that coming up with one would likely be difficult, because "really, all we agree on is that a depression is much more severe than a recession, and everyone agrees we haven't had one since the 1930s."
When it comes to searching for definitive explanations, Reagan may have gotten it right back in 1980. In that same speech, he said, "Human tragedy, human misery, the crushing of the human spirit … They do not need defining—they need action."
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