RE-FI GAMES

Allan Sloan explains the mysterious world of mortgage financing:

It̢۪s not only confusing, it doesn̢۪t even operate according to something as basic as the law of supply and demand. In fact, it̢۪s the opposite. The more demand there is for refinancing, the lower rates tend to get. The less demand, the higher rates tend to get.

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Refinancing is great for us borrowers. If interest rates go down, we refinance. If rates go up, we keep our mortgages. But refis are wretched for investors who own mortgages: Fannie Mae and Freddie Mac, pension funds and such. Fannie and Freddie have borrowed huge amounts of money and have to pay it back; pension funds have to send checks to present and future retirees. They want the payments they get from the mortgages they own to be in sync with the obligations they have to pay. Timing is everything for these guys.

When refis ramp up and exceed expectations, mortgage owners get back money they had expected to be profitably invested for years. Things get out of whack. So the mortgage owners need to “add duration,” as they say in the bond biz. So they run out and buy long-term securities. Lots and lots of them. In this case, the law of supply and demand works. Bond prices rise, which translates into lower rates.

It is rather confusing, especially since most people think mortgage rates are tied to the Fed rate.

FILED UNDER: Economics and Business
James Joyner
About James Joyner
James Joyner is Professor and Department Head of Security Studies at Marine Corps University's Command and Staff College and a nonresident senior fellow at the Scowcroft Center for Strategy and Security at the Atlantic Council. He's a former Army officer and Desert Storm vet. Views expressed here are his own. Follow James on Twitter @DrJJoyner.