By Jim Freer
Senior Contributor
CondoVultures.com
Condo buyers who are wondering if this week’s big moves by the Federal Reserve will make banks more willing to lend on residential in the short-term: Don’t expect it.
The reality is that any impact from the Federal Reserve’s interest rate cuts and its bailout of mortgage investor Bear Stearns will be indirect, and probably minimal, on residential lending in South Florida and around the country.
Banking and real estate analysts point out that the Federal Reserve’s discount rate for its overnight lending to banks and its Federal Funds rate target for overnight lending between banks, both cut since March 16, are not the indices lenders use to set residential mortgage rates.
The prime rate, which banks lowered following the Fed Funds cut, is an index for many business loans and home equity loans. But it is not an index for rates on mortgages to purchase or refinance condo units and houses.
Perhaps most importantly, condo market players should recognize that interest rates have not been the big factor in the past year’s tight lending market, said Jack McCabe, president of McCabe Research and Consulting in Deerfield Beach.
“No matter the rate, it gets back to the risk versus the reward,” said McCabe, who monitors the South Florida and national condo markets for institutional investors.
Even if mortgage rates go lower, McCabe expects terms for qualifying for loans will remain tough compared with two years ago.
“There is still a lot of volatility out there,” and many mortgage lenders and investors have not yet determined their losses, McCabe said.
For all types of lending, banks are not in an interest rate crisis but are deep into a credit crunch that makes them hesitant to lend, said Ken Thomas, a Miami-based banking consultant.
“They are shell-shocked,” Thomas said, with growing volumes of delinquent real estate loans and concerns that they could add more problem loans.
Amid last week’s intensive media coverage of the U.S. Central Bank, Thomas reminds prospective condo and house buyers that rates for their loan are driven by the U.S. Treasury market.
Banks and other lenders generally use the 10-year U.S. Treasury Note as their index for setting rates on 30-year fixed-rate mortgages.
Many use the 5-year U.S. Treasury Note as an index to set rates on 15-year fixed-rate mortgages and starting rates on some adjustable rate mortgages.
Short-term rates set by the Federal Reserve and long-term Treasury rates that are determined by bond investors are different markets.
“Long-term and short-term rates often move in opposite directions, and while the Fed has been cutting rates since last year, the rates on different Treasuries have been moving up or staying flat,” Thomas said.
In recent months, Treasury investors in the United States and overseas have been more
concerned than the U.S. Central Bank has been about the potential rise in U.S. inflation.
Another factor is that with the U.S. Dollar’s fall against numerous other currencies, “some foreign investors are not buying as much debt as they did a few years ago,” Thomas said.
Since mid-February, rates on long-term Treasury Notes and most key mortgage rates have dropped between 0.10 percent (10 basis points) and 0.30 percent (30 basis points) – much smaller drops than in the Federal Reserve’s 2008 cuts in its Federal Funds rate.
On March 18, the U.S. Central Bank cut its Federal Funds target by 75 basis points from 3.00 percent to 2.25 percent. The same day, most banks cut their prime rate (3 percentage points added to the Federal Funds rate) from 6.00 percent to 5.25 percent. That is a rate that banks often charge on business loans to some of their most credit-worthy borrowers.
This chart compiled by Condo Vultures® shows how the U.S. Central Bank raised the Federal Funds rate for several years, to keep the economy from over-heating. The Federal Reserve began cutting that rate in September 2007 as part of its attempt to reduce the impact of the housing crisis.
On January 22, the U.S. Central Bank cut its Federal Funds target from 4.25 percent to 3.50 percent. On January 30, the Federal Funds rate target was cut to 3.00 percent.
The Federal Reserve sets that target by using its own financings to reduce or increase the amount of cash available to banks in the overnight market.
One of its main tools is buying and selling short-term Treasury bills, in the market for transactions with commercial banks and investment banks.
If the U.S. Central Bank buys Treasury bills, it leaves banks with more available cash and thus enables them to lower their rates on overnight loans to each other.
With the economy slumping and many businesses and consumers having less money to deposit, many banks in Florida and elsewhere have faced liquidity crunches and more need for access to short-term cash.
“But the liquidity the Fed is adding does not necessarily equate to more lending, especially now when we have so much uncertainty in the credit markets,” the Miami consultant Thomas said.
On March 16, JP Morgan Chase announced an agreement to buy investment bank Bear Stearns, one of the largest investors in the deteriorating subprime mortgage pools where many loans are now in default.
In an unprecedented agreement for bailing out a non-FDIC insured company, the Federal Reserve will provide JP Morgan up to $30 billion to cover any losses.
“They (Fed) put out a fire,” Thomas said. “It could be a major step in averting a growing financial crisis.”
Bear Stearns was an investor in numerous Special Investment Vehicles (SIVs) and other mortgage pools, and its collapse might have produced huge losses for many banks and other institutional investors that have holdings in those pools.
In Main Street terms, the Bear Stearns bailout might be a major step in cleaning up and accounting for this decade’s mortgage mess.
If banks starting with the big players see progress, Thomas said he expects the process of restoring confidence could begin.
That process likely will take a year or more to unfold.
As it does, start looking for banks to gradually and selectively increase their lending on condo units.
Jim Freer is senior contributor to Condo Vultures.com who writes a weekly column that appears every Thursday. Freer is a veteran financial journalist in South Florida and a consultant to the financial services industry. He can be reached at JimFreer@aol.com. Be sure to check out the Condo Vultures® blog at CondoDump.com. Don't forget to sign up for our weekly Market Intelligence Report
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