The Federal Reserve’s recent rate cut won’t help millions of people facing spikes in their monthly mortgage bills.
That’s partly because their mortgage rates and terms are set by global investors in London, rather than in the United States.
Adjustable-rate mortgages (ARMs) with low initial rates and payments that increase in three to five years became popular — and even a necessity — during the housing boom as escalating home prices put buying a home increasingly out of reach, especially for young people and minorities buying their first homes.
By last year, ARMs with initially affordable payments were used in more than half of the home sales in Washington and other big cities.
But the fate of these borrowers now lies overseas.
Three-quarters of the ARMs taken out by buyers with shaky credit standings and about a quarter of the hybrid ARMs taken out by those with good credit ratings are tied to the London Interbank Offered Rate, or LIBOR, which is set by global banks in London.
In addition, global investors who had been buying riskier loans are now spurning them.
That is a dramatic change from only a few years ago, when most ARMs in the U.S. were tied to the prime rate set by American banks or rates on Treasury bills largely controlled by the Fed. At the time, the Fed could provide immediate relief to overburdened ARM customers with rate cuts, but now the Fed is only one of many powerful global forces that determine the level of such short-term interest rates.
“The United States and its financial system no longer stands alone the way it once did,” said Christopher Cagan, research director at First American/CoreLogic, a financial-information company. “It”s not the sovereign world the way it was in the 1960s.”
Foreign investors — from Chinese bureaucrats to European banks and Middle Eastern sheiks — have become indispensable buyers of U.S. debt, whether issued by the Treasury, corporations or individual home buyers whose loans are bundled with other mortgages and sold as a package to investors.
Foreigners own nearly half of the U.S. Treasury”s debt, a third of U.S. corporate debt, and nearly a fifth of the mortgage securities backed by Fannie Mae and Freddie Mac, said Joseph Quinlan, chief market strategist at Bank of America Corp.
Although the foreign investment helped fuel the housing boom, that gusher of support is not likely to be repeated, he said.
“Given all the problems in U.S. housing and the toxicity of the U.S. mortgage markets, foreigners are not likely to boost their share” of mortgage debt any time soon, he said.
The enormous foreign appetite for such U.S. paper in recent years was linked to huge U.S. trade deficits. Because the U.S. imports far more than it exports, it sends out more than $800 billion into the world economy each year than it draws in, placing that money into foreign hands, Mr. Cagan noted.
The widespread placement of U.S. debt throughout the world is the reason why the subprime debacle that broke out this year as U.S. default and foreclosure rates spiked has had far-reaching global consequences and why U.S. borrowers are having a much harder time getting foreigners to open up their wallets and lend to them again, he said.
“A lot of the money was international, and a lot of the losses were international,” he said, noting that major banks in France, Britain, Germany and Asia, as well as in New York, have suffered losses as a result of their loans to U.S. home buyers.
The whims of foreigners means that some less-worthy U.S. borrowers may not get loans at all, and the Fed”s one-time stranglehold on the level of U.S. short-term rates has been loosened.
The Fed still exercises an inordinate amount of influence over short-term rates, and its Sept. 18 half-percentage-point rate cut served to lower key short-term rates globally — from the one-year LIBOR rate tied to most subprime mortgages to the one-year T-bill rate tied to many prime loans.
But the powerful central bank”s influence will be increasingly muted by growing global forces that are essentially beyond the control of any one country, analysts say. And at times, its influence may be dwarfed by other factors, as it was briefly in August when a credit scare drove the LIBOR and other short-term rates sharply higher despite strenuous efforts by the Fed and other central banks to bring them down.
For subprime borrowers and other ARM customers, the biggest problem will not be so much which global rate their loans are tied to, but the onerous terms of the mortgages and loose lending practices that put them into mortgages and houses they could not afford in the first place, Mr. Cagan said.
“If you have a teaser loan that starts at 1 percent and winds up at 7 percent, the Fed rate cut will not change the fact that there”s a doubling” of the mortgage payment built into the loan, he said. The sudden doubling of mortgage payments will be unaffordable to most of the subprime homeowners who took out the loans and will result in millions of loan defaults and foreclosures.
“There are still going to be problems. I don”t care whether it”s linked to Treasury bills or LIBOR,” he said.
Andrew Jakabovics, analyst with the Center for American Progress, noted that LIBOR rates have recently been out of sync with Fed-administered interest rates, thus offering little hope of relief for people whose ARMs are tied to them.
But “even if the LIBOR eventually moves slightly south due in part to the Fed”s rate cut, this is not going to bring a rush of credit back to the segments of the mortgage market most in need of refinancing,” he said.
“Homeowners most in need of help are unlikely to be deemed creditworthy by suddenly wary financial lenders” at any interest rate, he said. “This means mortgage-foreclosure rates will continue at their current, torrid pace, threatening not just the holders of these home loans, but also their neighbors and their communities as home prices plummet.”
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