Mortgage Q&A: Treasury bonds keep U.S. afloat

Last week, I reported that the Federal Reserve Board intends to keep interest rates low for an extended period of time to help the economic recovery. With unemployment at a 26-year high of 10.2 percent, it is probably a pretty good decision. Mortgage rates have stayed low primarily because inflation continues to remain in check and the Fed is continuing to purchase massive amounts of mortgage-backed securities, which is creating a constant demand for mortgages.

I speculated that even when the Fed ceases these purchases, private investors will step in because the quality of these securities is so much better than the pre-mortgage-meltdown days.

Since then, I read a column written by a well-known political commentator. Instead of politics, his piece was about the necessity to preserve the value of the dollar in this global economy. It was a very sobering and pessimistic view on what could happen to the U.S. economy. Here’s a summary:

The price of gold has been on the rise, and some say it could triple in the coming years. This is possibly an indication that the faith in the U.S. dollar is waning. Federal government-issued Treasury bonds are traditionally seen as the safest investment on the planet. Foreign investors, including gigantic countries such as China, continue to purchase Treasury bonds at an enthusiastic pace.

The U.S. debt, which is financed by the issuance of Treasury bonds, is approaching $12 trillion.

The commentary centered around one general question: What if global demand for Treasury bonds declines in a big way? How would we finance our military needs, our various government stimulus plans, our corporate bailouts, and our proposed health care overhaul?

The answer is simple. Everything has its price, and it all deals with supply and demand. The Fed is already providing plenty of supply and, apparently, will need to continue to do so. So far, there’s also plenty of demand, which is thankfully keeping long-term rates - including mortgage rates - low. If the demand wanes, the price of these bonds will fall and rates will rise substantially.

From a mortgage and real estate standpoint, this would be very bad news. If mortgage rates rise two or three points, consider what would happen:

The modest amount of real estate transactions going on today would come to a halt.

The lack of activity would cause property values to fall further.

The current refinance activity would stop, preventing homeowners from saving a few bucks that would have gone back into the economy.

Entire industries might be out of business - lenders, mortgage brokers, title companies, developers, construction companies, suppliers, etc.

There’s no way that I can predict whether a scenario such as the one described in this column will become a reality. And I’m certainly not on a mission to fear-monger. However, this scenario seems to me to be at least possible.

Henry Savage is president of PMC Mortgage in Alexandria. E-mail him at henrysavage@pmcmortgage.com.