On Interest Rate Risk

The Sunday New York Times has an article about banks not refinancing mortgages much right now. In his speech on Saturday, the President blamed large financial institutions for the recession. Others in the article suggested that banks should be more willing to refinance mortgages, and many would want to because interest rates are low.

Financial institutions were at fault but so was the government. Government policy encourages homeownership in many ways, including pushing regulated banks to find creative ways to help poorer risk families obtain mortgage financing. Ultimately, banks and other financial institutions got on the bandwagon, ultimately paying very little attention to "due diligence."

Interest rates are low right now, but the article also points out that the low rates are due to government programs that probably will phase out soon. In other words, rates will be going up. A bank that refinances potentially locks in for 15 or 30 years at a low interest rate. If interest rates begin rising in a few years, the bank cannot force the borrower to accept a higher rate. That is, the banks bear the interest rate risk. Securitization has been one of the methods used to get rid of the interest rate risk. But securitization is part of the "risky loans and complex financial products," that the President complained about in his speech.

I had hoped that the current recession would lead to changes in behavior. There are signs that households are wising up and increasing their savings while reducing their debt. It is not clear that financial institutions have made changes other than ones necessary to comply with government concerns. And, it is not clear the government is making any lasting changes. There is still a push to encourage wider howeownership, the building of new homes despite the large inventory of unsold homes, and the ever-constant desire for low interest rates. We may have missed a depression in the economy, but I find the situation today depressing.