30- year loan rates rising

Why are interest rates on 30-year fixed-rate mortgages rising even as the Federal Reserve slashes interest rates and yields on Treasury bonds fall? The answer is that the mortgage market is short of roughly $1 trillion in capital. The modern mortgage market works with lots of leverage, or borrowed money. Investors, including hedge funds and mortgage real estate investment trusts, buy mortgage securities, but finance a lot of their purchases with this leverage. The Federal Reserve Board estimates that $11 trillion of outstanding U.S. mortgage debt is supported with roughly $587 billion of equity. That’s a leverage ratio of 19 to one. But last year’s subprime meltdown has undermined confidence in the home loans that back these mortgage securities. Now the banks that finance most of these leveraged mortgage investments have started to pull back and impose margin calls, demanding more cash or collateral to back their loans. This has sparked a de-leveraging cycle in which some highly leveraged mortgage investors have to sell assets to meet margin calls. Forced selling pushes prices lower, sparking more margin calls, which in turn produces more selling and even lower prices. When debt prices fall, yields rise and that’s what’s happening to mortgage securities – even those backed by government sponsored entities including Fannie Mae and Freddie Mac which are considered the safest. The immediate impact is that interest rates on 30-year fixed-rate mortgages will have to increase relative to Treasuries. That is why we are experiencing pressure on mortgage rates despite the downward movement on the 10-year bonds. Rates on 30-year fixed mortgages usually follow the movement of 10-year Treasury bonds, but this relationship has broken down as de-leveraging in the financial system takes hold.