Something is going deeply wrong in Housing Market

Summary

This video explains how mortgage rates are influenced by factors beyond just the Federal Reserve's interest rates, such as the role of mortgage-backed securities, institutional investors, and the broader economy. It discusses the history of Federal Reserve interventions, the challenges caused by rising government debt, and the current dynamics that are keeping mortgage rates elevated. The video offers a deep dive into why mortgage rates are unlikely to fall significantly in the near future despite potential cuts in Fed interest rates.

Takeaways

• 😀 The housing market is experiencing strange conditions that could potentially raise mortgage rates to levels unseen since the 1970s and 1980s.
• 😀 Many people mistakenly believe that when the Fed lowers interest rates, mortgage rates will also decrease, but that's not how the system works.
• 😀 Banks borrow money from investors, not directly from the Fed, and then loan it to consumers at higher rates, pocketing the difference.
• 😀 30-year mortgages are risky for banks, but they have historically been made possible by mortgage-backed securities (MBS) that are sold to investors and backed by the U.S. government.
• 😀 The Federal Reserve stepped in to buy MBS during the 2008 financial crisis and again during the 2020 pandemic, which artificially lowered mortgage rates.
• 😀 The Fed has been selling off MBS since 2022 to reduce its balance sheet, which has led to rising mortgage rates due to oversupply in the market and weak demand.
• 😀 The demand for MBS is largely driven by institutional investors, such as pension funds, insurance companies, and foreign investors, all of whom seek relatively low-risk, stable returns.
• 😀 The devaluation of the U.S. dollar has made MBS less attractive to foreign investors, reducing demand and contributing to higher mortgage rates.
• 😀 Rising yields on government bonds are influencing the yield on MBS, making mortgage rates rise as well, especially with the growing national debt and deficit.
• 😀 Even if the Fed lowers interest rates, the current supply-demand imbalance in the mortgage market and other macroeconomic issues could keep mortgage rates high.
• 😀 Investors can earn higher returns from riskier assets like stocks or MBS, but they must carefully analyze their investments to avoid losses, especially in uncertain economic conditions.

Q & A

Why do people assume that if the Fed lowers interest rates, mortgage rates will also decrease?

People mistakenly believe that if the Federal Reserve lowers interest rates, mortgage rates will follow suit. However, the mortgage market works differently, as banks borrow money from investors, not the Fed, and mortgage rates are influenced by demand for mortgage-backed securities, not directly by the Fed's rates.

How do banks typically fund mortgages, and how does that affect mortgage rates?

Banks usually borrow money from investors at a certain interest rate and then lend it to consumers at a higher interest rate. The difference between these rates is the bank's profit. Since banks rely more on investor funding than the Federal Reserve, mortgage rates are influenced by investor demand, not the Fed's rate changes.

What are mortgage-backed securities, and why are they important in determining mortgage rates?

Mortgage-backed securities are bundles of mortgages that are sold to investors. They are crucial because the rates on these securities influence mortgage rates. Banks sell the securities to investors, who are paid based on the interest from the underlying mortgages. If demand for these securities decreases, mortgage rates increase.

Why did mortgage rates drop to historic lows during 2020 and 2021?

Mortgage rates dropped during 2020 and 2021 because the Federal Reserve intervened by purchasing trillions of dollars in mortgage-backed securities to stabilize the market in response to the economic challenges caused by the COVID-19 pandemic.

What role did the Federal Reserve play in the housing market after the 2008 financial crisis?

After the 2008 financial crisis, the Federal Reserve began buying mortgage-backed securities to stabilize the housing market, as the collapse of the housing market posed a significant risk to the broader economy. This intervention helped drive mortgage rates lower.

How did the Federal Reserve's balance sheet change after the 2008 crisis and during the COVID-19 pandemic?

The Federal Reserve's balance sheet expanded significantly after the 2008 crisis and again during the COVID-19 pandemic as it purchased large amounts of mortgage-backed securities to support the housing market and prevent further economic downturns.

What impact did the Federal Reserve’s decision to sell mortgage-backed securities have on mortgage rates?

When the Federal Reserve began selling mortgage-backed securities in 2022 to reduce its balance sheet, the increased supply of these securities led to a decrease in their value and a rise in mortgage rates due to lower demand from investors.

Why do banks prefer not to hold long-term mortgage loans like 30-year fixed-rate mortgages?

Banks avoid holding long-term mortgages like 30-year fixed-rate loans because they are considered risky. The uncertainty about future economic conditions, such as recessions or inflation, makes it difficult for banks to predict the stability of their investment over such a long period.

What is the relationship between government bonds and mortgage-backed securities in determining mortgage rates?

Government bonds and mortgage-backed securities are linked because both are types of debt investments. Investors compare the yields on government bonds, which are considered low-risk, to those on mortgage-backed securities. If government bond yields rise, mortgage rates tend to increase as well, because mortgage-backed securities must offer a higher return to remain attractive to investors.

How does a weaker U.S. dollar impact foreign investment in mortgage-backed securities?

A weaker U.S. dollar reduces the returns for foreign investors, as the value of the U.S. dollar decreases when converted into other currencies. This devaluation makes mortgage-backed securities less appealing to international investors, potentially lowering demand and pushing mortgage rates higher.