Federal Reserve head Alan Greenspan and his colleagues hiked the federal funds rate to 4.25 percent today, the 13th increase since June 2004. With all eyes on the Fed, the burning question arises: So what?

Real estate industry professionals have been wringing their hands ever since the Fed began raising the federal funds rate in 2004. They feared that as the overnight bank rate went up, so would interest rates on 30-year fixed mortgages.

But interest rates on such mortgages still hover around 6.6 percent – not a high rate at all. What gives?

The federal funds rate is the interest rate banks charge each other for overnight loans. Conventional wisdom says that as that rate goes up, so do long-term rates. But obviously, it ain’t necessarily so.

In other words: though there has long been a relationship between the bank rate and long-term interest rates, the two are not exactly locked in a passionate embrace. Maybe it’s more like a cousin and an uncle.

“The fact that short-term interest rates are rising while long-term interest rates are not rising simply underscores that there is little direct relationship between what the federal funds rate might be and what mortgage rates might be,” said Keith Gumbinger, vice president of New Jersey-based financial publisher HSH Associates.

In fact, Gumbinger and other industry experts said long-term interest rates might actually drop.

“It’s not unreasonable to think that as the Fed raises short-term interest rates and, by doing so, helps quell any inflationary threat, that long-term interest rates might be stable or perhaps even decline,” the vice president said.

“Long-term rates are reflective of the price of money plus an inflation premium. Little inflation means little premium,” Gumbinger said.

Even better news: “It’s certainly possible that interest rates for fixed-rate mortgages in 2006, while higher than in 2005, may not be much higher than current levels, provided inflation remains tame,” according to Gumbinger.

If interest rates remain low, with inventory growing and prices softening in some areas, could another real estate boom be in the making? Alas, that’s going a bit too far, according to Gumbinger and others.

“We don’t have the conditions necessary to create a new boom,” Gumbinger said. “Booms are created as interest rates continually decline over a longish period of time.”

But Gumbinger had good news for the mortgage industry.

“There’s a very good likelihood that adjustable-rate mortgages that are coming due for their first or continuing adjustments in 2006 will find holders of those products looking at alternatives including refinancing to fixed-rate mortgages,” Gumbinger predicted. “Activity levels of refinancings are likely to be pretty solid.”

Marcus Ortega, a senior investment executive with the J.P. Turner brokerage, agreed with Gumbinger that mortgage interest rates aren’t necessarily on the way up.

“The higher the Fed raises the bank rates, the more the Fed calms foreign investors about inflation,” hence keeping rates low, Ortega said.

Many folks currently on the real estate scene have never seen interest rates higher than 8 percent. But, Ortega pointed out, in the early 1980s, interest rates were in double digits.

“In 1981, the U.S. was trapped in an inflation spiral. Paul Volkner, who was the chair of the Federal Reserve, boosted the Federal funds rate to 18 or 19 percent and that broke the inflation spiral,” Ortega explained.

“That made the bond market happy, we didn’t have to worry about inflation and erosion to our bond principal. Bond prices rallied from 1981 up until now,” Ortega said.

The executive sees the 10-year note as “a great barometer for a general sense of where mortgage rates might go.” The 10-year bond is now at 4.5 percent interest, Ortega said.

The executive said, “People are worried about mortgage money going back to 7 percent. But that’s not a disaster. Back in 1992 and 1993, 7 percent mortgage money was cheap. A 7 percent interest rate for a 30-year fixed mortgage is in the lower 20th percentile historically.”

Industry experts surveyed by Inman News have said that only if interest rates reach 8 percent will the market be affected.

“At 6 and 7 percent we still see upward movement or, at worst, sideways-moving price projections,” said Michael Sklarz, chief valuation officer for Fidelity National Financial. “But at 8 percent, some markets have prices falling.”

As long as the Fed doesn’t continue to raise interest rates, Mitchell Grashin, a loan broker with Oakland, Calif.-based Holmgren Associates, is optimistic, he said.

“They really need to slow down those raises,” Grashin said. “This is the last hurrah for Greenspan. They are going to let him go out on his terms with his raises and the new guy next year will do a little diminishing of those raises and maybe flatten them out.”

Grashin was referring to the fact that Greenspan is retiring, with his successor Ben Bernanke slated to take the reins in 2006. Greenspan’s final Fed meeting is on Jan. 31.

A number of economists believe that the Fed’s interest hikes are coming to an end, with one final quarter-point increase expected at the Jan. 31 meeting. Even those who expect Greenspan’s successor Bernanke to do some rate raising don’t foresee the federal funds rate going above 5 percent.

“Most banks are expecting the Fed to slow down their raises next year,” Grashin said. “They released the minutes of their September meeting and they were talking about ‘maybe we’re going overboard with these raises. Maybe next year we’ll slow it down a bit.’ This is why rates have stayed low.”

***

Send tips or a Letter to the Editor to janis@inman.com or call (510) 658-9252, ext. 140.

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