Higher Mortgage Rates Could Snuff a Nascent Housing Recovery

(MoneyWatch)  Housing finally had some good news this week. According to the National Association of Realtors, pending home sales rose 6.7 percent compared to March, the third consecutive increase and the largest jump since October 2001. The indicator was also 3.2 percent higher than in April 2008.

Pending home sales are a measure of how many homebuyers agreed in April to buy a previously occupied home. Since there is often a delay of several months between signing a contract and closing on the deal, the index reflects future home sales.

According to the realtors' chief economist, Lawrence Yun, a key reason for the surge was the $8,000 first-time buyer tax credit created in President Obama's stimulus package. "Since first-time buyers must finalize their purchase by Nov. 30 to get the credit, we expect greater activity in the months ahead, and that should spark more sales by repeat buyers," Yun said.

The pending home sales index was the strongest in the northeast, increasing by 32.6 percent compared with March's numbers. In the midwest, the index climbed 9.8 percent and the West rose 1.8 percent. The index in the south fell 0.2 percent, but is 3.5 percent higher than a year ago.

In another piece of good news, the head of the National Homebuilders Association said the housing sector had probably seen the worst. "Indicators look like we are at or near a bottom in housing," said NAHB chairman Joe Robson.
So why isn't everybody cheering? Well, there was some negative news, too. The government said new home sales in April rose only 0.3 percent from March, meaning it would take 10 months to clear the number of new homes at the current sales rate. "The industry still suffers from over three million too many vacant homes," said Stifel Nicolaus analyst Michael Widner in a note to investors.

Another bad piece of news emerged on the mortgage front. The Mortgage Bankers Association said its index of mortgage volume for new mortgages and refinancing fell 16.2 percent from a week earlier. The refinance index fell a whopping 24.1 percent in just one week.

The cause of the falloff was a sudden increase in interest rates. According to the bankers' association, the average interest rate for 30-year fixed rate mortgages increased to 5.25 percent from 4.81 percent the previous week.

Tom Marano, chief executive of mortgage operations at GMAC, the former financing arm of General Motors, told Reuters that home loan volume had declined about 75 percent compared with two months ago, when interest rates were at record lows.

The Federal Reserve has begun buying $300 billion in U.S. Treasury bills and $1.25 billion in mortgage-backed securities in an effort to bring mortgage rates down to an affordable level.

Fed Chaiman Ben Bernanke told a Capitol Hill hearing this week that rising bond yields were a sign that investors are nervous about the Obama administration's budget deficits, expected to be near $2 trillion this year. Mortgage rates are closely connected to yields on Treasuries and often move in tandem.

"These increases appear to reflect concerns about large federal deficits, but also other causes, including greater optimism about the economic outlook, a reversal of flight-to-quality flows, and technical factors related to the hedging of mortgage holdings," Bernanke said.

What does this all mean? Early indications that the economy is recovering are sending interest rates higher. But higher interest rates mean less money is available for people to buy a home. That in turn will keep the economy from recovering. It's a circular argument, but one that the Fed must address if the government hopes to keep the nascent recovery alive. Bernanke needs to get those interest rates down.