January 2008

“Will the recent 3/4 point drop in the Fed Funds Rate help the local Orange County Real Estate market ?”… I’ve been asked this quetion several times today, and my asnwer is “Yes” and “No”….  May sound like an answer from a political candidate, but let me explain my “have it both ways” answer. 

First of all, here is the “NO” part of the answer.  The Fed Funds Rate has had little correlation with actual 30 Mortgage rates in the past 8 years.  Mortgage rates are most closely tied to 10 year treasuries.  While long term adjustable rate mortgage (ARM) rates are often tied to prime rate, LIBOR and other factors.  Look at the graph below from the year 2000′ to the year 2005′.  Around January 2001′, the 30 year mortgage rates were around 7% and the Fed Funds Rate was around 6.5%.  1.5 years later, the Fed Funds Rate dropped to about 1.8%, yet 30 mortgage rates were still hanging around 7%…  Then in mid 2004′ Fed Fund Rates went from 1% up to 3.5% by the end of 2005′, while 30 mortgage rates stayed around 6% during this period of time.

So based upon the past 8 years (and more) of history, I don’t see that this recent large  drop in the Fed Funds Rate will do much in lowering Mortgage Rates… which still happen to be very low historically. 

The recent major downturn in real estate prices here in Orange County is the result of two effects - One a natural correction… or a letting off of steam if you will, from the overheated and overextended run-up in prices that took place from about 1998′ until early 2006′.   And two, is the result of the record breaking foreclosures and pre-foreclosure sales that are occurring due to the large number of loan defaults.  These defaults are primarily caused by overextended buyers who were given highly leveraged loans with adjustable mortgage loans with artificially low teaser interest rates in the past 1 to 4 years.  A slight drop in long term mortgage rates (if they drop at all due to the Fed Funds Rate), will not be much help to these homeowners in financial distress.    

The “Yes” part of the original question comes into play as follows.  The lowering of the Fed Funds Rate should help to stave off a recession, which should help to prevent future job losses, which should help to prevent future Foreclosures.  Plus this should give the current pool of potential home buyers additional confidence to buy now or soon, if they feel good about their long term local employment.  In addition, the Fed Funds Rate drop also acts as a positive psychological effect in that it is somewhat reassuring to know that the powers of government are making some serious attempts to resolve the current economic troubles.