Thursday, September 10, 2009

Sensitivity of the mortgage market to monetary policy and credit conditions

The mortgage market is one of the most sensitive of all financial markets to changing interest rates and money and credit conditions. For example, as interest rates rise, the mortgage market is affected from two different directions. Lenders are forced to reduce their mortgage commitments in the face of rising interest rates due to usury laws in some states which impose maximum interest-rate ceiling. In addition, commercial banks, savings and loan associations, and mutual savings banks lose deposits due to disintermediation as their more interest-sensitive depositors seek more-attractive investment opportunities elsewhere. With fewer deposits coming in, a smaller volume of funds is available for mortgage loans, and what funds are available usually carry higher rates. Finally, the total cost of a home goes up as interest rates rise, and this depresses the demand for housing. In many ways the mortgage market is a "boom-and-bust" affair, growing rapidly in easy money periods when interest rates are relatively low and contracting sharply in high-rate , tight-money periods.
Fannie Mae, Ginnie Mae, Freddie Mac, and other government mortgage agencies have helped to stabilize the market to some extent by purchasing mortgages in tight-money periods and selling them in times of easy money and rapid credit expansion. One obvious problem, however, is that this approach frequently goes against Federal Reserve monetary policy designed to stabilize the economy and fight inflation. In tight-money periods, for example, the Federal Reserve System attempts to reduce the volume of borrowing and spending in the economy through high interest rates and slower growth of the nation‘s money supply. However, because these developments would tend to depress the mortgage market and reduce the availability of mortgage funds, government mortgage agencies will respond by purchasing mortgages and making loans to private mortgage-lending institutions.
Conversely, when the Federal Reserve attempts to pull the economy out of a recession by promoting low interest rates and more rapid money-supply growth, the government mortgage-lending agencies tend to sell mortgage in the secondary market and cut back on loans to the housing sector. Thus, the activities of the government mortgage agencies probably contribute to economic instability to an indeterminate extent. This is a clear example of a conflict in the nation‘s economic and social goals-stabilizing the economy versus supporting the housing industry.

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