Mortgage rates are puzzling; some fear quick rise

Interest rates have been rising, but not mortgage rates. That's good for home buyers but has left economists puzzled and spurred fears of a real-estate investment bubble.

BY NELL HENDERSON
Washington Post Service

Mortgage rates were supposed to be rising by now, helping to gradually cool the nation's red-hot housing market.

The Federal Reserve has been raising short-term interest rates steadily for nearly a year. The economy is growing at a healthy pace. Energy costs are up. If history were a guide, long-term rates would be rising, too.

But they are not. Even Fed Chairman Alan Greenspan has called this a "conundrum."

Defying predictions, U.S. mortgage rates are lower than they were a year ago and are falling. That's a large part of why home sales and prices are at record highs and are fanning worries of a real-estate investment bubble.

The rate on the average 30-year, fixed-rate mortgage nationally fell to 5.62 percent this week, the lowest rate since mid-February and below the 6.32 percent level of a year ago, according to mortgage financier Freddie Mac. The average 30-year rate in Florida fell to 5.367 percent Thursday.

"The housing market is going to be robust if rates stay where they are," said Freddie Mac's chief economist, Frank Nothaft. "But it's hard for me to fathom why they would stay this low for long."

While home buyers cheer the bargain borrowing costs, some economists admit to being puzzled and concerned. If mortgage rates keep sliding, they will pump up any bubble. But if rates snap up suddenly, a bubble could pop, with both prices and investment dropping sharply, hurting many borrowers and investors.

In Miami, this possibility is particularly troubling, with more than 60,000 condominium units planned or under construction in the next few years.

"That's what everyone's worried about," said Bill Heffernan, president of Totalbank in Miami. "What are interest rates going to be 18 to 36 months from now when all these condos come on board? If rates shoot up, how many people are going to close on their units?"

For now, the home mortgage business at his bank is booming. "People still feel like they can get a cheap mortgage," Heffernan said.

Global financial markets, not any government body, determine long-term interest rates through their bond trading each day.

High demand for bonds pushes up their price and drives down their yield, yield being their effective interest rate after factoring in their purchase price.

A combination of factors keeps driving demand and pushing rates down, forces that have "much more to do with speculation, hedging and politics than . . . with actual investment merit," wrote Peter Schiff, president of investment firm Euro Pacific Capital, in a recent analysis. "Once these forces reverse, expect bond prices to plunge and interest rates to soar."

Mortgage rates are largely determined by the yield on the 10-year Treasury note.

Last June, when the Fed's benchmark short-term rate was 1 percent, the 10-year yield was 4.69 percent and the average 30-year mortgage rate was 6.25 percent.

Since then, Fed officials have raised their benchmark federal funds rate, which is charged on overnight loans between banks, to 3 percent and indicated they plan to move it higher to keep inflation in check.

But the 10-year yield has fallen below 4 percent, to 3.88 percent earlier this week -- the lowest level since March of last year.

Some analysts are now predicting it will keep sliding. Merrill Lynch's interest-rate committee last week lowered its yield forecasts, projecting the 10-year Treasury to yield 3.8 percent by year's end.

Morgan Stanley's chief economist, Stephen S. Roach, on Tuesday predicted that the yield could reach 3.5 percent in the next year.

That represented a turnabout for someone who had insisted for months that interest rates would eventually rise as part of a correction of the nation's huge trade deficit.