The higher rates translate into higher payments for anyone thinking about buying a house or in the process, if they haven't locked in the rate. When you get a mortgage you have so many days to lock in a rate. You can wait and hope the market moves with you or you can lock it in immediately. Once you lock in, you're set.

What you have is people who are thinking about buying a house or who have made an offer, but haven't locked in, suddenly looking at higher monthly payments for the same loan amount. They may or may not be willing or able to make these higher payments. If not, then they will not buy or, if they've already made an offer, not close on the house (early on in a sales contract, it's not that hard for buyer's to walk away).

We already have an oversuppy of housing, which is driving home prices down. The foreclosure crisis is adding to that, since foreclosed houses tend to sell for even lower amounts. What increased mortgage rates do is drive buyers either into lower priced homes or out of the market altogether. That drives housing prices down further.

I was going to post on this separately, but real life keeps interfering. Bill Moyers interviewed George Soros, who said a lot of interesting things. Relevant to this post, he discussed how the market had overpriced homes and that if we weren't careful it would over-correct so that home prices fell below their real value due to foreclosures. He said what others have said, that we have to deal with (cram down) mortgages:

BILL MOYERS:Well, don't be shy. What do you think the new government should do?

GEORGE SOROS:Well, first of all you have to prevent housing crisis from overshooting on the downside the way they overshot on the upside. You can't arrest the decline, but you can definitely slow it down by minimizing the number of foreclosures and readjusting the mortgages to reflect the ability of people to pay. So you have to renegotiate mortgages rather than foreclose.

And you provide the government guarantee. But the loss has to be taken by those who hold the mortgages, not by the taxpayer.

BILL MOYERS:You mean the homeowner doesn't take the loss. The lender.

GEORGE SOROS:The homeowner needs to get relief so that he pays less because he can't afford to pay. And the value of the mortgage should not exceed the value of the house. Right now you already have 10 million homes where you have negative equity. And before you are over, it will be more than 20 million.

Rates for new fixed rate mortgages went up, which usually drives prices lower for home sales. Existing fixed rate mortgages have - as the name says - fixed rates.

I'm no finanical expert and find the article a little hard to follow, but it appears what happened is that Fannie and Freddie sold either previously bundled mortgages or commercial paper and the price on that dropped, which means the yield or interest rate is higher (like a bond). Somehow that is supposedly making interest rates for newly originated loans go up, although if their cost of funds is falling I'm not sure why that would make interest rates rise ???

Somehow that is supposedly making interest rates for newly originated loans go up, although if their cost of funds is falling I’m not sure why that would make interest rates rise ???

This is why I keep talking about 'the commodification of money'. Arbitrage has resulted in an equilibrium of sorts between all kinds of investments -- all investments are valued relative to the rest of the market -- and the only people making real money on investments right now are those who quickly take advantages of shifts in the relative value of investments.

The easiest way to explain this is with CDs. Lets say that a year ago, I bought a 5 year CD for 10,000 with an interest rate at 5%. If the interest rate on new 4 year CDs is now 4%, I can sell my $10,000 CD for considerably more than $10,000, because it has the same maturity date as a new four-year CD, but has a higher yield for the same risk.

It no longer matters what the government is charging in terms of interest rates -- the market immediately adjusts to those changes through arbitrage.

Fannie and Freddie don't set interest rates, they sell bundled mortgages -- and people who are willing to buy mortgaged backed securities determine the value of those securities -- it doesn't matter what the interest rate on the mortgage loans themselves is, because the market determines the risk/return ratio, and if the yield in the rest of the market is 7% for outstanding "solid" mortgage backed securities, that is the yield that Fannie and Freddie will have to give investors in order to sell its securities.

In order to do that and still make a profit, Fannie and Freddie can only buy mortgages from banks that yield more than 7%. And that means that the banks have to charge more than 7% to make money on their mortgage business.

This is why cutting interest rates has little impact on the economy as a whole. Because there is so much debt out there already, its the market for that existing debt that determines what interest rate a business will have to pay in order to get capital to expand.

That's why I keep talking about graduated transaction taxes. Its the arbitrageurs -- the people who immediately take advantage of any changes in the market by moving vast sums of money around very quickly -- that reap the lions share of the benefit of anything designed to stimulate or stabilize the economy; and all they with their profits is use them to move even more money around and enrich themselves. High "sales" taxes on investments held for a very short time makes short term investments far less profitable than longer term investments if longer term investments have lower (or no) "sales" tax, and taxation is the most efficient way to return stability to the fiscal marketplace.

As always Treasuries sell at the highest prices/lowest yields. Heretofore Fannie and Freddie paper sold at high prices/low yields relative to other paper because there was an implicit understanding that the federal government would back that paper. Now the federal government has made an explicit guarantee that it will back that paper.

This guarantee reduces the risk of holding Fannie and Freddie paper. This should make the paper more attractive to investors, driving up the price and reducing the yield of Fannie and Freddie paper. However that's not what is happening.

These days there is a new implicit understanding that lower priced/higher yielding bank paper has the backing of the government -- at least for banks that are too big to fail. (The bank paper has nothing directly to do with mortgages -- mortgages are only part of a bank's portfolio.) Investors believe that this implicit guarantee is about to become an explicit guarantee.

Therefore investors are selling their Freddie and Fannie paper -- the low-yield stuff -- in favor of buying higher yielding bank paper. Investors reason the higher yielding bank paper is as secure as the lower yielding Fannie and Freddie paper because they believe it is all guaranteed by the U. S. government these days.

If the risk of holding bank paper is seen as no higher than the holding of Freddie and Fannie paper, the prices of each must converge (though they haven't yet).

The first time I read the article I was confused but now I see this is what it says:

Investors responded to the new guarantee by buying existing bank debt, reckoning it could be refinanced with the new government-supported bonds. As they did so, they sold lower-yielding paper issued by Fannie Mae and Freddie Mac, the mortgage companies put into government conservatorship last month.

The sales of Fannie and Freddie paper pushed up yields on their debt, which is backed by mortgages. This, in turn, pushed mortgage rates to levels not seen since the government took over Fannie and Freddie on September 7.

Just as new Treasury debt sells for essentially what old Treasury debt sells for in the (Fed's) open market, new Fannie and Freddie debt sells for what the old Fannie and Freddie debt is going for. (The obligations of the issuer to the bearer does not change over time. However, the value of a security in the open market is always in flux after it is issued. Its price is determined by its duration (when it is due), its yield (its future redemption price minus its present cost), its coupon rate, if any (i.e. what the issuer periodically pays to the bearer while the note is outstanding), its rating (i.e. the likelihood of the issuer being able to redeem it, which fluctuates over time) and current interest rates in the financial markets which, of course, fluctuate over time.

If the government sends a signal that it will back General Motors paper you will see investors selling their bank paper and rushing to buy whatever low cost/high yield GM paper is out there.