First a little history. The Federal Reserve System (commonly referred to as The Fed) is the central banking system of the US and is made up of 12 regional banks. The Fed manages the nation's money supply via its use of monetary policy. This refers to The Feds ability to influence the availability of money and credit which affects interest rates and therefore the economy.
Are we good so far? For our purposes here we are going to have a limited discussion and only touch upon one area of the monetary policies.
Banks are required by The Fed to have a certain portion of the total value of their demand accounts on hand. If a bank falls below this level, it can borrow the funds from another bank that has a surplus with The Fed. These are typically overnight loans. The interest rate on these borrowed 
funds is determined by the banks themselves but is influenced by The Fed via the Federal Funds Rate. These are more closely aligned with short term interest rates. This is the rate that we've been hearing so much about in the news. It must be understand that this is a target rate set by The Fed. The rate that is actually paid by one bank to another is negotiated between the two parties. This has nothing to do with mortgage rates.
Now we come to mortgage rates. The Fed DOES NOT control mortgage rates. Mortgage rates are market determined and are on the long term end of the interest rate spectrum. These are generally determined by the bond market. It's a financial market where debt securities are bought and sold. And this brings us to Mortgage Backed Securities. You may not have heard of these specifically, but you've most likely heard of Fannie Mae, Freddie Mac and to a lesser extent Ginnie Mae. Basically what they do is package many mortgages together and issue them as MBS's. In order to get investors to buy these, they must pay rates of interest that are competitive with alternative interest-paying investments such as Treasury bonds. There is a correlation between mortgage rates and long term interest rates. Long-term rates are governed by the overall health of the economy, and the expectations of future growth.
As you can see one is long term whereas the other is short term. So when you hear that The Fed cut the rate, you can not always expect an equal and immediate change in the mortgage rate. In fact, in many cases the opposite has occurred.
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Thanks Marc. We seem to have a knee jerk reaction when we hear that the Fed lowered "the rate". Many immediately expect mortage interest rates to come down accordingly.
Of course, it doesn't happen. I have to chuckle when I hear one of the financial "experts" discuss the Fed rate in connection with mortgage rates.
Fact is, lately, it's almost impossible to connect the present day mortgage rate to the Fed action. Now, what's going to happen if MBIA gets their rating reduced.
Care to speculate on that domino.
Good information. Thanks for posting financial stuff that we can understand.
Marc... what an excellent explanation that so many fail to understand. I am going to add this to this blog post. Mortgage Interest Rates - Up or Down? I think it's a great ending to a somewhat confusing issue. And in regards one of Lenn's comment, I often cringe when a financial expert on tv mentions both Fed Rates and Interest Rates within a 2 minute period. Especially when they don't break down the difference. Hence, leaving the average consumer more confused or assuming that one follows the other. And I am flagging this, because I think this is a worthy feature.
Jeff - Thanks for your comment and adding that link. And I see that I got flagged, that's very kind of you to suggest such. I tried to make this as simple as possible without giving too much information to confuse the matter or too little to not understand it. I gather by yours and Lenn's comments that I've succeeded.
In regard to the media, I agree with both Lenn & yourself. But the problem that I see is that the people reporting do not have a good enough grasp of the subject matter to properly write about it and that's where the confusion comes from. Like with anything else either you educate yourself prior to saying something or keep your mouth shut if you don't know. Unfortunately, too many people have diarrhea of the mouth. I guess they can say that about my writing - Oh Well!
Marc...
I have had a very long hard physical labor kind of day. I'm pooped. In fact I do believe I'm too pooped to pop :)
If it's okay with you I am going to park until tomorrow.
Thank you for not charging me the going rate on parked comments :)
TLW...ROAR!
Marc,
Nice explan ation. We all get optimistic when the Fed cuts rates --Just wish it was that easy.
Lanre - Thank you very much. In fact many times the mortgage rates have done the opposite of what the fed funds rate did.
TLW - You can park and/or hijack anytime your wish. Your visiting is more than enough.
Diane - So do I, but...
Great post, and a great explanation to something even many in the mortgage industry don't get.
As far as the monolines like MBIA and ABK getting ratings cut, it's gonna happen, even the ratings agencies such as Moody's have said unequivocally it's coming and a capital raise won't stop it. I think they're doing there best to give lots of warning ahead of time, in hopes the market will adjust (which it isn't) and lessen the impact. They cut a couple of the smaller credit insurers such as SCA this week, a warm up. The effect is likely going to be very wide reaching, and it's hard to even speculate on it's extent at this point.
I don't see successful government intervention here, but I do expect it in the case of the largest mortgage insures, Freddie, Fannie and Ginnie.
Lola - Thank you very much and glad that I could assist.
Jimmy - Thank you.
Paul - That was my point. I plan on using this post in my next newsletter.
Mark - Very good and this is sometimes true as it was with the 75 basis point cut in January in which mortgage rates actually rose 50 basis.
Matt - I didn't think that would stop the cuts either - the raising of capital. I do appreciate your knowledge and input. I do see where you are coming from as to the gov't intervention. I'm just thinking here and it boggles the mind what's going to happen when MBIA and their ilk get their rates cut. It's not even going to be a ripple effect, there are going to be some major dominos. The banks, the investors, the markets - Geez!
Marc, great post. I know everybody here was asked the question when the feds lowered the interest rate 2 weeks ago, are mortgage rates going to drop. I too was one of those that didnt understand what affects does the fed cutting the rate have to do with mortgage rates. One thing is for sure that i knew that the mortgage rates were not in line with the feds rates. I will be adding this to my favorites. I have a clear understanding of whats going on now..
Marc,
Thanks sooo much for this great insite!!!
I want to copy it into my presentation portfolio, if that's ok!!!! (credit to you, of course!!)
Bernie
Thanks Marc,
Now can you please explain this to my Canadian relatives.
John Hurbon
Tierra Antigua Realty
Benson Horse Property
I LOVE LONGWOOD FLORIDA ----------------
Fantastic Mr. Grossman! SOMEBODY should post this in a major media publication and put it on the first page...right beside all the other Mortgage News going around. Well studied and well put man, you taught me a little bit of something....
Belonger was right in flagging this, wonderful 'freaking' article. We really could structure a College Course around this very entry into the Blogosphere. Yet, I'm sure you are like me...why wait for College? Good work Mr. Marc!
Richard - And it's not as complicated as some may think either.
Freddie - Glad this helped you.
Wayne - Thanks, but people needed to really know that there isn't a relationship between the two.
Lisa - What this 'even by me' crap. I don't believe that for a minute.
Bernie - Go for it. I hope that it'll help.
Rob - Thank you, but I think it's important for all of us to know this info. As realtors we need to understand these concepts and how they relate to our industry.
Adam - You are exactly correct and thank you very much.
Joey - Thank you for that compliment. I tried to keep it simple and concise. Bang away.
Trace - And it's all of our jobs to understand the difference. How else can we explain it to others.
Brian - Thank you kindly.
John - I could try... Glad you like my neck of the woods.
Christy - It's so very important and quite interesting. Thank you.
Jason - Thank you, thank you, thank you. I humbly bow before you!
BLR Guy - Thank you.
Matt - Thanks, that's so kind of you.
Great job explaining the the Fed RAte and Mortgage Rate.
Loan Officer
Flagstar Bank
704-671-8670
http://www.flagstarloans.com/rwalton
Building relationships that last.
Emily - Glad you enjoyed.
Robert - Thanks. The links should also help to possibly better understand how all this works.
Marc,
Congratulations on the feature. Well explained!
Mike in Tucson
Marc,
Great post... I'm printing this out and giving it to my customers that asked about rate adjustments and the fed cuts rates... real pro job... thank you...
Rick
Marc,
This is awesome detail! Thank you for setting the record straight.
Jeff - Glad this could be of assistance to you. Thanks for the compliment
Rick - Be my guest and thank you.
Sherri - I felt that it had to be done. I realized that not only is it confusing to the general public that also realtors are confused as well. This is something that we should know to be able to properly assist our clients.
Excellent explanation of the Fed rate and interest rates!
Jonas - Thank you very much!!