Rate Watch #688 Rates Down! Did the Fed Help Create the Mortgage Mess?
September 18, 2009
by Dick Lepre
[email protected]
www.loanmine.com
V) Role of Fed in Housing Bubble
I have read a lot recently blaming the housing bubble on the Fed's monetary policy. In its most extreme form some believe that the Federal Reserve is largely responsible for the housing bubble by having made rates too low during the brief post-9/11 recession.
I believe that while low rates were contributory they were by no means the heart of the problem. The housing bubble was created by 1) HUD's insistence that FHLMC & FNMA do subprime and dictating the spread above prime that the interest rate on these loans was to be 2) Wall Street's dishonest packaging of subprime with prime to make all of these investment grade 3) the lack of ethics and lack of honesty of the loan officers who worked with the people who got mortgage they could not afford 4) the general lapse in underwriting standards which enabled more people to do stated income which both burdened people with mortgages they could not afford and served to buoy prices 5) non-securitized bad Option ARM loans which destroyed WaMu and World Savings/Wachovia.
The Federal Reserve controls short term interest rates. Longer term interest rates are set by the market and are largely a function of inflation not the overnight rate. It must be noted here that the Fed is at present a more important player in mortgage rates since the subprime collapse but that is after the fact.
Yes banks had low borrowing costs and those low borrowing costs were caused largely by the Fed but low borrowing costs had little correlation with bad lending practices. In fact if interest rates were too low the lower yield to investors should have discouraged any investor from buying what were in fact high risk securities. But investors were deceived by the investment banks and the debt rating firms into believing that securities backed by subprime loans were investment grade.
Other than HUD one other part of the government which enabled this was SEC when they increased investment banks leverage ability.
In summary, the Fed rate did not dictate mortgage rates. Mortgage rates were affected more by HUD and the Wall Street investment banks. The loan officers who did the actual connections with the borrowers did not suddenly have any lapse of ethics because that was minimal to begin with.
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