Mortgage rates take a devilish drop
By Holden Lewis • Bankrate.com

You would expect people to take advantage of lower mortgage rates, but that's not what happened this week.

The benchmark 30-year fixed-rate mortgage fell 8 basis points, to 6.66 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.40 discount and origination points. One year ago, the mortgage index was 6.58 percent; four weeks ago, it was 6.77 percent.

The benchmark 15-year fixed-rate mortgage fell 8 basis points, to 6.18 percent. The benchmark 5/1 adjustable-rate mortgage fell 8 basis points, to 6.26 percent.

Weekly national mortgage survey

Results of Bankrate.com's Aug. 20, 2008, weekly national survey of large lenders and the effect on monthly payments for a $165,000 loan:

Even as rates dropped, mortgage applications fell to their lowest level in almost eight years. The Mortgage Bankers Association's index of loan applications was down 1.5 percent compared with the previous week, and was down 34.2 percent compared with the same week last year.

Why did rates retreat?
Pinpointing the reason for this week's decline in rates is difficult. Inflation tends to drive interest rates higher, and the news about inflation wasn't good. The Producer Price Index, a measure of wholesale prices, shot up 1.2 percent in July. Excluding food and energy, prices went up 0.7 percent. Those are the month-over-month figures, comparing July prices with June prices. Year over year, wholesale prices rose 9.8 percent.

The jump in July wholesale prices was bigger than expected. Normally, you would expect interest rates to rise on such news, but they didn't.

Joel Naroff, chief of Naroff Economic Advisors in Holland, Pa., summarized it thusly: "Inflation is way too hot, and with housing way too cold, we have the opposite of a Goldilocks economy."

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Indeed, housing is as cold as an ex-spouse's heart. The Census Bureau reported that single-family housing starts fell in July to the lowest level since January 1991. Builders started construction on single-family houses at a seasonally adjusted annual rate of 641,000. That was a 39 percent decline compared with the previous July.

Mortgage bankers and brokers say most of their business is coming from purchases. Few homeowners are refinancing.

Ominous news for Fannie, Freddie
There is some ominous news in the mortgage world. Fannie Mae and Freddie Mac, which guarantee mortgages and keep the secondary market in mortgages running, suffered further declines in their stock prices this week, and investors were reluctant to buy debt issued by Freddie Mac. Many speculated that one or both companies would be bailed out by the Treasury Department.

A bailout could take the form of an outright takeover by the federal government. That would be bad for stockholders, whose investments would be wiped out, or nearly so.

The effect on borrowers isn't so easy to gauge. Some in the mortgage industry believe that a government takeover would be followed by an increase in rates because of uncertainty surrounding the transaction. Others speculate that a takeover would end the period of uncertainty, not start one, and the effect on rates would be benign.