What’s Up With Mortgage Rates?

As the BankRate graph to the left shows, mortgage rates have been trending down quite dramatically over the last 6 months and remain near recent record lows. That shouldn’t be too surprising since the government has been using the printing presses to buy up gobs of mortgage backed securities (MBS). But everyone is wondering what happens when the music stops – and it is scheduled to stop at the end of March.

I got to thinking about this question a couple of days ago as I was watching Ben Bernanke testify at one of those daily congressional hearings*. Allegedly, the inquisitors were attempting to figure out what was going to happen to mortgage rates when the government ends their purchase program. Ben admitted that he really didn’t know but it didn’t sound like anyone believed that rates were going to go up by even 200 basis points.

And then I started to think about how the fixed income markets work and it dawned on me that, in theory, mortgage rates shouldn’t move up by much at all. Why not? Because mortgage rates are basically a function of the rates earned on the mortgage backed securities. You can’t charge any less than what investors are willing to earn. And these investors are not stupid. They know that the feds are going to start sucking money out of the MBS market come March. So if they had any concerns about rates going up (and the value of their investments going down) they would be requiring a higher rate today. In other words, the return on MBS shouldn’t be much lower today than people expect them to be at the end of March. Would you be willing to lock in a 5% investment today if you thought you could get 7% at the end of March?

However, apparently I’m in the minority in this view – exactly where I like to be. 80% of the participants in the most recent BankRate survey believe that mortgage rates are heading up in the next 30 days, though Dan Green, whose blog I just linked to, agrees with me – albeit for different reasons. Of course, this BankRate survey is only 30 days out and it doesn’t quantify the expected increase. Maybe people aren’t expecting big increases. Anyway, you can hold me to my forecast but I’ll give you one other thing to chew on: it’s often hard to beat the naive forecast (the academic name for forecasting tomorrow to be the same as today) in the financial markets.

* I see this poor guy on CNBC almost every day. I don’t know how he can get any work done. And to call these things “hearings” is a huge misnomer. They’re more like a series of 5 minute grandstanding commercials by the congressmen talking about how they saw the truth long ago and voted for legislation to avoid all our problems and now they are going to make people like Ben Bernanke squirm in front of their constituents so that all the people back home can see how smart they are and how they really care about the little people, who should vote them back in office.