Why are mortgage rates up if the Fed is cutting?

Interest rates on long-term lending are based largely on the rates paid by the U.S. Treasury when it auctions off new paper to fund budget shortfalls. Because Treasuries are considered the gold standard of safety, turning over your money to other lenders is considered riskier — so the interest rates you get are a little bit higher. When an investor with money to lend in the capital markets get nervous, they demand an even higher interest rate to make up for the risk that they won’t get paid back.

During the easy-money days of the housing boom, investors showered cash at mortgage loans and asked relatively little extra “risk premium” in return. The feeling was that housing prices would continue to rise forever, and investing in mortgages – which paid higher returns than “super safe” Treasuries — was a no-brainer. Or so it seemed at the time. Now that home prices are falling, that risk premium — the “spread” between the higher rate on mortgage loans and the benchmark rate on Treasuries — has widened.

As long as that’s the case, the Fed could cut short-term rates to zero, and it wouldn’t cut the cost of long-term mortgage rates.

What is a recession?
— Kathy, Bettendorf, Iowa

Mr. Bernanke was asked this one in his testimony to the Senate Banking Committee, and the answer he gave was a little clearer.

“Recessions are generally ‘called,’ so to speak, by a committee called the Business Cycle Dating Committee, which is part of the National Bureau of Economic Research, a committee of which I was once a member, by the way, which looks at a wide variety of indicators to see essentially if the economy contracted over a period of time,” Bernanke said. “And it's a somewhat subjective decision and is often made well after the fact, because of the revisions of data and so on.

“A more informal but widely used definition of recession is two consecutive quarters of negative growth. That would be an alternative that people use," he said.

Using the second definition, the economic data has yet to confirm that the U.S. economy is in recession. The widest measure of growth, the Gross Domestic Product, rose by 0.6 percent in the last three months of the year — the latest data available. That’s down sharply from the 4.9 percent growth rate in the third quarter of 2007 — but it’s still growth, not recession.

The GDP, according to the keepers of the data, measures “the output of goods and services produced by labor and property located in the United States.” But it’s an average of all regions and all industries; the housing industry is clearly in a deep recession, as are some parts of the country, especially in the industrial Midwest.

Some readers — along with some economists, Senators, investment managers and CEOs — believe we’re already entering a national recession.  So the entire U.S. economy could well be in the middle of the first of those “two consecutive quarters of negative growth.” But because it can take months for the economic data to be collected and revised, we won’t know for sure that a recession has hit until at least the second half of this year at the earliest. 

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