The law of unintended consequences continues. We may save the banks at the expense of the homeowners.
The government's effort to boost bank lending to end the credit crisis is hurting one of the areas critical to the nation's recovery: mortgage rates. In the past week, the average mortgage rate on a 30-year fixed home loan has jumped more than one half a percentage point to 6.74%, according to Bankrate.com. That might not sound like much, but it is the biggest one-week rise in the normally stable lending rate in 21 years. Some economists say mortgage rates could soon top 7%, a level they have not seen in more than six years.
Last month, when the government took control of mortgage giants Fannie Mae and Freddie Mac and pledged to inject $200 billion in capital into the home loan guarantors, administration officials said the moves would make it easier and cheaper for people to get home loans. Unfortunately, it hasn't worked that way. Mortgage rates fell sharply after the move, but soon reversed quickly, and are now higher than they were before the Fannie/Freddie rescue plan was launched.
The problem is that other moves the government has made to render bank debt safer has had the unintended consequence of making Fannie and Freddie's bonds less safe by comparison. So Fannie and Freddie's investors have to be compensated for the increased risk. In particular, traders say, the move in the past week by the Federal Deposit Insurance Corp. to temporary offer unlimited deposit insurance for non-interest bearing accounts and guarantee roughly $1.4 trillion in new unsecured bank debt has caused a rush of selling of the bonds of Fannie and Freddie. That's because the FDIC's move makes bank debt more attractive at a time when traders are looking for safety.Sheila Bair, the head of the FDIC, was initially against backing this new bank debt, but eventually went along with Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson.
Lower prices (and thus higher interest rates) for Fannie and Freddie bonds make it more expensive for the government mortgage guarantors to borrow, and that means that Fannie and Freddie have less money to purchase home loans. Which means a lower supply of capital available for mortgage issuers. The result is higher mortgage rates for the average American.