The American economy, like most world economies today, is run on a system of fiat money, or money that is assigned its value by government decree. Since this money has no intrinsic value of its own, its value and supply must be carefully managed and regulated, not just within the nation’s borders but also in accordance with the economies of all other nations. In light of this need for careful stewardship of the economy, the United States maintains a central bank, called the Federal Reserve (or, more commonly, the Fed).

The Fed as it exists today is actually the United States’ fourth attempt at founding a central bank. In the midst of the Revolutionary War, America’s Continental Congress ratified the Articles of Confederation, which, among other edicts, gave Congress the power to issue bills of credit. A private national bank, modeled after the Bank of England, was established shortly thereafter, but was denied the opportunity to become a central national bank due to unease about foreign influence and other political concerns. The official First Bank of the United States was created in 1791, and lasted 20 years before being denied a renewal of charter by President James Madison. The Second Bank of the United States opened in 1816, and it too only lasted 20 years before President Andrew Jackson shut it down. Political opposition to the very idea of a central bank had been a chief culprit of these failures, and it would be almost a century before the United States would try again.

In 1907, a profound financial panic occurred, a direct result of a failed attempt by stock traders to corner the market on shares of the United Copper Company. The failure created a series of bank runs on those institutions that had backed the bid. As is often the case with bank runs, the atmosphere of worry spread nationwide, causing other banks to suffer runs and even leading to the collapse of, at the time, the third-largest financial trust in New York City, the Knickerbocker Trust Company. With no central bank in existence to attempt stabilization of the economy with an infusion of currency, the only reason that the crisis did not fling the country into irreparable economic turmoil was the work of private business tycoons such as J.P. Morgan, who banded together and contributed much of their own capital to bolster the banks. It was this barely dodged catastrophe that led to a series of financial reforms over the next few years, culminating in 1913 when Congress and President Woodrow Wilson passed the Federal Reserve Act.

In structure, the Federal Reserve is unique among the world’s central banks. Although it is designed to function as an entity “independent” of the federal government, thereby limiting its exposure to political influence, the Fed also employs a mixture of private and public sections in its operation—most similar banks in the world operate under either entirely private or entirely public ownership. It is also the only such bank to not make its own currency (which is instead printed by the United States Treasury). The Fed is managed by a Board of Governors, all of whom are presidential appointees, and is also comprised of the Federal Open Market Committee (FOMC) and representatives from twelve other Federal Reserve Banks located throughout the country.

The Fed has been reformed a number of times since 1913, especially so after the recovery from the Great Depression. Currently, its chief mandate is to provide the means to deal with bank panics, but it also sets interest rates, operates as a lender of last resort in case the banking system is in need of capital, and generally regulates the entire money supply by balancing the factors of employment rates and inflation. The importance of these functions to the American economy cannot be overstated. Any competent financial player in any market knows that a key component of success or ruin is an ability to observe, analyze, and possibly predict the actions of The Fed…and any competent Board of Governors is aware that The Fed is being closely watched.

Unless you’re fortunate enough to pay for your new home in full right up front, you will need some sort of loan to make your purchase—and having a loan means having to pay back that loan, over time, with interest. However, anybody with a sense of the housing market right now will tell you that interest rates are about as low as they’ve ever been, and that this is the perfect time to purchase or refinance your property.

Interest rates can be complex no matter what they are, and it’s helpful for you to understand that complexity.

To begin, consider the differences between a conventional and a jumbo loan. Simply put, a conventional loan is any loan for $417,000 or less, and a jumbo loan encompasses all loans above that figure. The primary difference between the two is who backs the loan—a conventional loan is backed by Fannie Mae or Freddie Mac, and is therefore easier to obtain than a jumbo loan, which is backed by private banks or investors. The risks inherent in a jumbo loan are therefore more pronounced. This risk drives up the interest rates.

At current, the national average interest rates for a conventional loan are at historic lows for a 30-year fixed-rate mortgage and ARM (adjustable rate mortgage) loans. The ARM’s rate is typically lower specifically because an ARM is designed to last a very short amount of time, and its interest rates will tend to fluctuate along with the market. The jumbo rates for both 30-year fixed mortgages and ARM’s are becoming more and more competitive at nearly a full percentage point lower than they were at this time last year.

Keep in mind, however, that there are numerous factors that go into the calculation of an interest rate, and that no two borrowers are exactly the same. Credit scores, characteristics of the property, the nature of the financing…all of these things and others will raise or lower the final interest rate on your loan. (Credit score, especially, will have a major effect on your interest rate.)

The prime rate issued by the Federal Reserve originally described the interest rate a highly credible borrower could expect—although this is not necessarily the case today. Today, the prime rate may or may not affect interest rates offered by banks or other loan providers; it is not so much a regulating figure as it is a reference figure, to be considered or ignored depending on the individual circumstances of each loan.

Interest rates have hit their all-time low because of the poor state of the economy…and while everybody would rather see the economy rebound, when it does, these low rates will rise back up with them. If you’re in a position to take advantage of these rates, then you absolutely should do so now!

Current Interest Rates: Barry Schwartz, PERL Mortgage Advisor and National Top 100 Producer, discusses current market conditions, interest rates, the differences in rate fluctuation between conventional and jumbo loans, rates for ARM’s and fixed-rate products, and recent compensating factors considered by banks when approving loans.

Click the play button to listen!

Market Comment
Mortgage bond prices rose last week, which helped mortgage interest rates improve. Oil prices continued to fall early in the week. Fortunately, mortgage bonds rallied nicely amid the tame inflation environment. However, that trend reversed mid week as oil prices spiked due to a report which indicated a supply decline. Stocks also surged higher as earnings reports generally pleased investors. The DOW easily eclipsed the 11,000 mark.

Despite this, rates still managed to improve by about 1/4 of a discount point for the week.

Today’s leading economic indicators data will set the tone for trading this week. The producer inflation data will be the most important release. If inflation pressures emerge mortgage interest rates may be pressured higher.

Durable Goods Orders
Durable goods orders are generally believed to be a precursor of activity in the manufacturing sector because manufacturing must have an order before considering an increase in production. Conversely, a decrease in orders eventually causes production to be scaled back; otherwise the manufacturer accumulates inventories, which must be financed.

Unfortunately, durable goods orders data has many drawbacks. The first problem with the orders data is that it is extremely volatile. This is usually attributed to the civilian aircraft and defense components of the figure. For example, if Boeing has a big order for one of its jumbo jets, the civilian aircraft category can change by $3-4 billion. The same scenario is evident when an aircraft carrier is ordered, surges in the defense category result. The second problem with the data is that orders are continuously being revised. There have been many times when the advance report on durables showed an increase, while a revision a week later showed a decrease. The revised data is found in the report on manufacturing orders, shipments, and inventories.

Since the data is difficult to forecast, there is quite often a huge disparity between the actual release and the initial projections. If the durable goods report is much stronger than expected, look for mortgage interest rates to push higher. If favorable, the data may help interest rates remain steady or even push lower.