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Mortgage News Reflects Conflicting Philosophies About Debt

This week’s mortgage news reflected something of a tug-of-war about what consumers should be doing in the face of the recession:

The first two items reflect the hope that consumers can be induced to start borrowing enough to spend their way out of recession. The second two items reflect the grim reality that underlying this recession is a debt problem that has to be addressed before the economy can get healthy again.

The “borrow more, spend more” camp

Lowering interest rates to stimulate spending, is a long-proven technique for easing economic slowdowns and recessions. This philosophy is behind actions that have driven 30-year mortgage rates down near record lows, and the possibility of further moves to drive mortgage rates still lower. There is even speculation that the Fed might cut short rates once again, though with those rates already down to 1% and bearing even less relationship than usual to market rates, some feel this would be primarily a token gesture to appease Wall Street.

While stimulating borrowing has worked in past recessions, the problem this time around is that household debt burdens are already near the breaking point. It may well be that Americans have little remaining appetite for borrowing, regardless of interest rates.

The “tighten the belt” camp

Soaring foreclosures and delinquent mortgages leave no doubt that debt is a problem. Typically, Americans are able to reduce debt during or shortly after a recession, putting them on sounder footing to sustain a recovery. However, instead of declining in or around the last recession, household debt service ratios broke through to record levels and stayed there throughout the economic expansion that followed.  

In other words, before they can start spending again, Americans need to bring debt levels down to controllable levels. The good news is they seem to be making an effort to do this, as indicated by the decline in household debt during the third quarter.

The good and bad scenarios

While high debt burdens mean that efforts to stimulate borrowing may continue to have a muted effect, the clear positive is that lower interest rates will help consumers pay down debt levels more quickly. One indication of this was the surge in mortgage application activity which followed the recent drop in mortgage rates. Most of this was refinancing activity, so while the main effect of lower rates has not been to stimulate demand, it should help households further reduce their debt burdens. This isn’t a quick fix, but it should put the economy in position for a sound recovery in the long run.

The gloomier scenario would be if unemployment got out of hand before all this had a chance to play out, foiling the efforts of many households to pay down debt. It’s a tightrope, but for the time being, lower interest rates do have many clear beneficiaries.

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