July 31st, 2008

The Final Shoe to Drop: Mortgage Resets and Interest Rates

I’ve been wondering why interest rates haven’t increased when evidence on all sides says they should:

  • we’re facing the prospect of significant inflation. Some say that the current inflation rate is in the area of 12-14% if they were recalculated on a basis consistent with the method used prior to 1998 (see Rating the Real Cost of Inflation).
  • The value of the $US has been consistently eroding
  • The budget deficit is unprecedented and continues growing. Without higher rates, foreign investors will stop funding this deficit at some point.

A Talking Head shed light on it yesterday (unbeknownst to them and surprising to me) when they made a comment that “mortgage foreclosures include fewer variable reset mortgages than originally anticipated because mortgagee’s can do so at affordable rates”. So that raised the question of what is going to be the flow of reset mortgages in the future and what, if any impact might that have on interest rates in the future.

I found the answer in a table prepared on a site called TheRealEstateBloggers.com at the beginning of the sub-prime mortgage credit crises on August 13, 2007. The table, entitled Adjustable Rate Loan Resets For 2007–2008 follows:

Month           Millions
January-07      22
February-07     25
March-07        35
April-07        37
May-07          36
June-07         42
July-07         43
August-07       52
September-07    58
October-07      55
November-07     52
December-07     58
January-08      80
February-08     88
March-08        110
April-08        92
May-08          76
June-08         75
July-08         50
August-08       35
September-08    26
October-08      20
November-08     15
December-08     17

What that means to me is that the Fed and Treasury have been consciously keeping rates low until the balloon in variable mortgage resets (Jan-July, 2008)!

And what might we expect as the majority of these mortgages complete their resets and convert to fixed rates (assuming those funds are available), there will be less incentive to keep rates low. I can see that interest rates will start edging up beginning Labor Day and will accelerate significantly as we approach New Years.

If true, what does this mean to stock investors? I think that will be the final shoe in this economic recession cycle to fall and trigger the last drop in the index and stock prices.

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