Interest Rate Roundup

Tuesday, August 21, 2007

Fed's Lacker dampens bailout talk, downgrades housing assessment

Richmond Fed president Jeffrey Lacker is on the tape with some comments that appear to dampen the speculation about an imminent cut in the federal funds rate. The general gist of his remarks? That the Fed can do other things (like cut the discount rate or flood the banking system with excess reserves) to ensure short-term liquidity, while keeping the longer-term federal funds rate target stable, assuming conditions in the "real" economy remain stable.

Meanwhile, he is downgrading his assessment of the housing market. The key passage:

"Even before the recent stint of financial market turbulence, the predominant concern on the real side of the economy was the outlook for housing activity. Residential investment fell rapidly over the last three quarters of 2006, but then the rate of decline slowed in the first half of this year. The question in my mind a couple of months ago concerned whether home-building would bottom out soon or continue declining. Recent data on actual housing market activity have dampened my optimism, however. Housing starts and residential building permits, which earlier this year looked as if they might be stabilizing, have both softened in the last couple of months. Broader measures of sales activity are also showing a pronounced downward trend.

"While the housing market implications of the recent financial market turmoil are quite unclear at this stage, there is a possibility that it will result in further increases in retail mortgage rates for some borrower classes and thus further dampen residential investment. Mortgage rate spreads have risen substantially for subprime borrowers, as one would expect given what has transpired, and for any borrowers with low down payments and low documentation. In the last few weeks, rates have moved up for jumbo mortgages as well. It is not yet clear, however, to what extent some of these increases will persist or to what extent they represent transitory responses to temporarily heightened uncertainty."

That fits with the comments I made earlier: If borrowers are forced to use conventional financing at current interest rates ... put 5%, 10% or 20% down ... and be qualified on the basis of reasonable debt-to-income ratios ... then home prices will have to come down to reflect the reduced buying buying in the marketplace.

That's not a bad thing, by the way, as far as I'm concerned. We shouldn't be trying to support inflated home prices that are way out of whack with borrower incomes. We should all hope instead that prices fall to a level that allows prudent borrowers to buy homes without resorting to suicide financing schemes.


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