For months now the Federal Reserve has been telling us that they plan to stop supporting artificially lower mortgage rates through their purchase of mortgage backed securities. In fact, they have gone so far as to tell us that the market is healthy and there should be no real issue if they ratchet down their purchases. The effective date of this change is March 31, 2010. So now what happens?
There are two potential outcomes from the Fed leaving the market. First, they are right. The support they have lent over the last year and a half or so is enough for the market to be normal on its own. This likely means that interest rates creep back over the next month or so to the level they were at before the Fed started buying. Translated, the market shows itself to be sustainable with interest rates much closer to six percent (6%) than the five percent (5%) that they are closer to now.
Option two is the “oops” option. It’s obvious that when the Fed stepped in, it was a necessary step. In fact, the market was getting pasted before that and lenders were not making loans, even to qualified borrowers. This caused a major problem that the Fed thinks has been cured. However, the Fed getting out of the market could have unforeseen consequences. In addition to the drop in rates, Fed purchases have provided an aftermarket for the loans being made. If there is no aftermarket, lenders may not be interested in purchasing the loans. If they cannot be purchased, they won’t be made. If they will not be made, real estate will not get financed regardless of how far prices drop, rates fall or motivated borrowers are. At that point, the Fed steps back in. In an effort to put the patient (the real estate market) back onto the program.
The analogy is this. Has the patient recovered enough to survive on his/her own? Or, has the patient found enough energy to get off life support but has no business leaving the hospital, much less the doctor’s care (Fed support). Only time will tell. We can only hope the Fed has this one right.
