Fed not to blame for mortgage rate rise


June 07, 1994|By John E. Woodruff | John E. Woodruff,Sun Staff Writer

What is the Federal Reserve doing to Maryland?

After boosting its key interest rates four times in as many months, a total of 1.25 points since February, the Fed has become a target of elected officials in a state that is only slowly and partially recovering from recession.

State Comptroller Louis L. Goldstein, the latest to join the fray, set forth last month a measured argument based on the impact rising mortgage interest rates can have on housing construction. Before speaking out, he had a staff economist analyze 10 years of data, from 1983 to 1993.

Every 1-percent increase in mortgage rates, the study found, costs Maryland 1,100 housing starts.

That is a chilling prospect. Given the weakness of Maryland's former economic mainstays, such as defense and manufacturing, this state's recovery is even more dependent than most on housing. What slows housing surely will retard economic growth.

And what slows housing is higher mortgage interest rates.

"Mortgage rates are up about a point and a half in the last few months, and that has completely stopped refinancing and added $100 to $200 to the monthly payments a buyer has to make to support a typical mortgage, and that slows down people who are thinking of moving up, which throws a real monkey wrench into the recovery," says Michael A. Conte, director of the University of Baltimore's Center for Regional Economic Studies.

But the rates the Fed controls are very different from mortgage rates.

The Fed works with extremely short-term rates, mainly the so-called "federal funds rate," the interest banks charge each other for overnight loans. It's a long reach from those rates to what ordinary mortals pay for 30-year loans to buy houses.

Overnight rates are set by the Fed. Mortgage rates are set by the market, mainly in response to long-term bond rates, and what the Fed does on short-term money is only one of the factors that influence bond investors.

"What influences long-term rates is investors' expectations of inflation," UB's Mr. Conte says, and any relationship between that and the Fed's actions on short-term rates is speculative at best.

When the Fed goosed the federal funds rate a quarter-point in February, long-term bond rates went up more than half a point. The conventional explanation was that long-term investors assumed that the Fed was seeing a threat of inflation that the market had not yet taken into account.

But when the Fed goosed short-term rates by twice as much last month, long-term bond rates did the opposite -- went down by a fraction of a point. The conventional explanation was that investors were becoming convinced at last that the Fed was serious about fighting inflation.

For Fed Chairman Alan Greenspan, that's the point: Raising short-term rates is about heading off inflation.

If the long-term bond market ever decides he really means it, many economists expect investors to do at least a bit more of what they did last month, which could bring the balm of easing mortgage rates to Maryland's recovery.

But that's a big if, and it depends less on action Mr. Greenspan takes than on the feelings and perceptions of highly sophisticated people who buy and sell long-term bonds.

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