How the Fed delays the next foreclosure wave

by Dan Krell © 2009

On Wednesday, the Open Market Committee of the Federal Reserve decided to keep the key interest rate unchanged ( The rationale provided was that although the economy as a whole shows signs of recovery, it continues to be fragile. The OMC cited signs of a recovery as the “abating” unemployment, expanding household spending, and a stabilizing real estate market. The economy continues to be fragile due to tight credit, lower household wealth, and the reluctance for business to hire new employees.

Although there is no direct relationship between the Fed’s key interest rate and mortgage interest rates, the monetary policy of the Federal Reserve’s Open Market Committee does affect investor behavior; a majority of mortgage interest rates are directly related to bond yields that are traded in bond markets around the world.

Since adjustable mortgages have historically been more sensitive to any Fed rate adjustment (up or down) due to the nature of its short term vulnerability, many homeowners with adjustable rates (that are expected to reset in the next several months) are probably unaware that they may have dodged a bullet (in the form of possible negligible rate adjustments).

If you recall, many homeowners in 2006 and 2007 purchased homes with adjustable rate mortgages that had teaser rates as low as 1%. Many of these homeowners may not have been able to afford the homes if they were qualified at the higher fixed rate mortgage. The anticipated foreclosure wave is to include many of these homeowners who cannot afford the higher mortgage payments when rates reset at a higher interest rate. However as interest rates continue to stay relatively low; the anticipated foreclosure wave continues to be delayed as adjustable mortgages resets stay lower than anticipate.

Because many adjustable rate mortgages are due to reset this coming year, financial experts expected the next foreclosure wave to peak between 2010 and 2012. The Fed’s continued monetary policy to maintain the federal funds rate between 0 and ¼ percent as well as continued purchases of mortgage backed securities (albeit at a continued slower pace) will most likely have the indirect effect of abating another wave of foreclosures.

It is unclear what message would be sent if the Fed took another tack on monetary policy; however one could speculate that it may have signaled the beginning of the second foreclosure wave and possibly the beginning of the double dip recession.

This article is not intended to provide nor should it be relied upon for legal and financial advice.