Rate cuts are benefiting lenders, not borrowers

Here's a very interesting graph, courtesy of FRED at the St Louis Fed:

The blue line at the top represents average 30-year mortgage rates in the US. The red line represents the effective Federal funds rate (what the Fed sets whenever they get together, with occasional forays into the market). The data on this graph goes back 12 months.

As you can see, there is a spread between mortgage rates and the Federal funds rate. It is this spread that usually represents the "profit margin" that lenders make when they lend money for mortgages. As you can see, for the first quarter of the graph, things were reasonably under control, with an average 1% spread between the two rates. Then notice that around May 2007, mortgage rates went up significantly, increasing the spread to around 1.5%.

August 2007 was, of course, when the market suddenly woke up to the fact that something awful was happening, and the Fed has since lowered rates significantly.

But notice - mortgage rates have not dropped by much at all. So while the Fed has been pouring money into the market, lenders have increased the "spread" between the Federal funds rate and the mortgage rate - which now stands at 3%.

What does this mean?

Put simply - it means that banks and other mortgage lenders are spooked. Even though mortgage rates have not changed much, the reduction in the Federal funds rate means that mortgage lenders have become very risk averse. They have money coming in, but not as much going out - a classic credit crunch scenario.

This "spread" is unlikely to change much in the short-medium term. So long as people keep defaulting on their mortgages and/or losing their jobs, lenders will keep their money on a short leash.

1 comment:

Reuben Kincaid said...

I guess the American banks are trying claw back some losses by maintaining their rates at a high level.