The 30-year fixed rate recently increased the most in one week since mid-April 1987.Â Freddie Mac reported that the average national Fixed Rate Mortgage (FRM) reached near 4.5% as compared with 3.93% in the previous week in mid-June 2013.
Why would interest rates suddenly spike skyward, and why would the Dow Jones index drop quite a bit during the same time period in late June 2013?
ANSWER:Â After a recent Federal Reserve meeting, Fed Chairman Ben Bernanke released some remarks in which he implied that the Federal Reserve may potentially â€œtaper offâ€ their future Quantitative Easing investments in which the Federal Reserve may possibly decrease their investments in stocks, bonds, and mortgages at some point in the near future.
What is the primary reason why both the Dow Jones stock index has reached 15,000+ and why interest rates have been near record lows during our ongoing Credit Crisis (www.thecreditcrisis.net)?
ANSWER: In my opinion, it is mainly due to the Fedâ€™s investment of seemingly trillions of dollars of capital in these stock, bond, and mortgage markets. The Fed admits to investing approximately $85 billion per month in Treasuries and Mortgage Bonds in order to better stabilize these markets, so that rates continue to stay low. Should this $85 billion monthly figure decrease, it may adversely impact the financial markets in a variety of ways.
How the Federal Reserve Creates Money â€œOut of Thin Airâ€
Our â€œFiat Moneyâ€ supplyÂ (assets backed by nothing) Â is created by The Federal Open Market Committee (FOMC), a group within the Federal Reserve System. As the saying goes, the Federal Reserve is about as â€œfederalâ€ as Federal ExpressÂ because the Fed is, in fact, a private consortium consisting of banks, investment banks, and other entities.
Since 1913, the Fed has been given their power under United States law to oversee Americaâ€™s â€œOpen Market Operationsâ€ in which the Fed buys and sells U.S. Securities. Additionally, the Fed makes key decisions about the present and future directions of interest rates, which directly impacts both individuals and businesses nationwide and worldwide.
Six Ways the Fed Creates Money
The Fed, by way of the Federal Open Market Committee (FOMC), creates money in the following ways:
1. When the government is short of funds, the U.S. Treasury issues bonds (fancy â€œIOUsâ€ for debt). The FOMC will also approve the purchase of U.S. government bonds on the â€œopen marketâ€ and third-party bond dealers will sell them off.
2. If the Fed wishes to increase the supply of money, they will buy more bonds from the independent bond dealers. In theory, this allegedly helps stimulate the economic expansion of the U.S. in both good and bad economic times. However, it does not always stimulate the economy in a positive way. In fact, an increasing supply of money can cause rapidly increasing rates of inflation, just like we have seen in recent years since the introduction of â€œQuantitative Easingâ€ and other bailout programs.
3. The Fed provides electronic credits to various banks in order to buy these same bonds. Supposedly, 97% of all â€œmoneyâ€ here in the US is created by way of computerized digits, thanks to the power of the computer keyboard. If true, then only 3% of all U.S. money may originate in the form of coins and dollar bills.
4.Â Fractional Reserve Lending: Banks, in turn, will use these same electronic credits, and loan them out to their banking customers in amounts leveraged 10, 20, 30, or 50+ times the same bankâ€™s existing capital reserves. For example, ABC Bank may have $10 million in capital reserves (electronic credits, cash, etc.).
Thanks to the magical powers of â€œFractional Reserve Lending,â€ the same bank may make $100 million + (or ten times their capital reserves) in loans to their banking customers for automobile, credit card, home, construction, or business loans. With many banks, their branches may have only 1% to 3% in actual cash reserves on hand in their bank vaults, which is primarily used for ATM machines.
5. Money can also be created if the Fed changes the reserve requirements for banks. If the Fed tells U.S. banks that they may decrease their reserve requirements, then banks will Â be able to make even more loans in the future while simultaneously keeping even lower cash reserves on hand.
6. If banks run too low on cash reserves, the Fed will give the banks loans by way of the â€œDiscount Rateâ€ for short periods of time at very low rates of interest. The banks will then charge their customers much higher rates of interest for various types of loans. The interest rate and fee difference between the Fedâ€™s Discount Rate loan to the bank, and the bankâ€™s loan to their customers will be profit to the same bank.
No Historical Precedence for the Credit Crisis Bailouts
Back when the worldâ€™s financial system almost collapsed (per Fed Chairman Ben Bernanke himself) in late September 2008, the Fed used a series of multi-trillion dollar bailouts, anonymous auctions, emergency loans, and other glorified â€œfinancial band-aidsâ€ in order to try to save many financial institutions, insurance companies, and investment banks from collapsing because they were deemed â€œtoo big to fail.â€
Many financial institutions have on and off balance sheet derivatives investments such as Credit Default Swaps and Interest Rate Options (both are akin to financial and insurance bets on the directions of future interest rates, investments, and other complex financial assets), which may equate to $1,500+ trillion dollars. This alleged $1,500 trillion of derivatives assets supposedly dwarfs all assets on planet Earth combined by a multitude of times.
ABC Bank may bet $10 trillion that interest rates tied to an index like LIBOR (London Interbank Offered Rate) may fall in the near term while XYZ Bank takes an offsetting bet that LIBOR rates may increase. In this scenario, somebody will win their bet while the other may lose badly.
Sadly, the financial bets are so interconnected worldwide that the implosion or collapse of ABC Bank can take down not only XYX Bank, but another ten or so financial institutions, which may be directly or indirectly tied in with ABC Bankâ€™s trillions of dollars of complex derivatives investments. This is why many of the bigger banks like the fictional â€œABC Bankâ€ are deemed â€œToo big to fail.â€
Quantitative Easing Infinity or Bust
The Fed has been the primary buyer of stocks, bonds, and mortgage bonds for the past several years here in the US. If the Fed stops buying trillions of dollars of Treasuries and mortgage bonds, then the 10-year Treasury yields will increase.
30-year fixed mortgage rates are tied to the directions of the 10-year Treasuries. Fewer buyers for Treasuries historically has led to increasing mortgage rates. How can the Fed really stop this hyper-inflationary â€œQuantitative Easingâ€ concept without potentially causing the stock market to fall?
How can the Fed stop buying so many Treasuries and mortgage bonds without causing interest rates to rapidly increase? Tragically, QE bailouts are weakening the value of the U.S. dollar which, in turn, is causing inflation to skyrocket for many goods and services such as oil or gasoline, food costs, clothing, and real estate prices in many regions.
For more proof of the importance of the â€œdouble-edged swordâ€ QE options, Fed Chairman Bernankeâ€™s recent comments about possibly â€œtaperingâ€ off their future Quantitative Easing investments caused some panic in the financial markets since so many â€œMom and Popâ€ investors and very well informed financial analysts are also quite aware of both the positives and negatives associated with QE policies.
I hope and pray that the U.S. economy may rebound on its own more so than continuing to have to rely upon bailouts from the Fed, and other sources worldwide. â€œCapitalismâ€ is typically an economic state in which the â€œFree Marketsâ€ sort themselves out with individual buyers and sellers than by way of governmental or Central Bank bailouts, as we have all seen in recent years.
Even so, the combination of low interest rates and increasing rates of inflation historically has helped the asset class of â€œReal Estateâ€ more than any other type of investment.
Read more: http://www.creonline.com/blog/why-real-estate-mortgage-rates-are-rising/#ixzz2ZzdsJacW