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When bombs fall, will mortgage rates rise?

War with Iraq seems inevitable, leading readers to ask: How will it affect my pocketbook?

More specifically, readers e-mail to ask whether they should lock in at today's mortgage interest rates. When the bombs fall, will rates fall, too? Will rates spike upward?

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"I have been frequently checking your site because I have a new home that will be delivered in April," a reader writes. "I am letting the mortgage rate float, but I have been wondering if the mortgage rates will go up or down if we go to war with Iraq."

Another reader asks: "If we were to invade Iraq, would interest rates be expected to go up or down? Our mortgage broker seems to think that they will increase after watching the rates following Secretary of State Colin Powell's speech last week. My thought is that they would tend to go down given the what-ifs surrounding war." Other readers weigh in with similar questions.

Here's the short answer (with a long explanation to follow): Mortgage rates might rise because a swift resolution to the war could trigger business investment, stimulating the economy. Or rates might remain about where they are as the economy continues to muddle along. Experts believe there is little room for rates to fall because they are low already.

The dominant theory is that uncertainty about war has held down rates, and that rates will rise if the war is short and successful. Others express skepticism about the belief that war jitters keep rates artificially low. They point out that the Gulf War and its buildup in 1990-91 exerted little effect on mortgage rates, and there were war jitters back then, too.

A brief history of war and rates
Let's look at that history. In the early '90s, "there were more important things going on affecting mortgage rates than the approach of the war and the resolution of the war," says Ken Mayland, president of ClearView Economics LLC.

Mortgage rates were in the midst of a decade-long downward trend, the economy was in recession and the Fed was stimulating the economy with a series of 18 interest rate cuts that chopped the overnight rate from 8.25 percent to 3 percent.

Fed rate cuts don't directly affect long-term mortgage rates, but the rate-cutting campaign of 1990-92 contributed to a climate of declining interest rates.

Today's circumstances are different. Back then, we were at the beginning of a two-year Fed rate-cutting cycle. This time, we're at the end of one. Back then, we were in a recession. This time, we're a year into another jobless recovery. Back then, mortgage rates were relatively high: The 30-year fixed rate averaged 9.59 percent the day before the allied bombing campaign began. This time, mortgage rates have been lingering near 40-year lows of just under 6 percent.

"The economic situation, the monetary policy of easing and where the economy is in terms of the recovery process -- these are different," Mayland says. "We're more advanced, more along the way this time."

The current military buildup has occurred at a sensitive time. This sluggish economic recovery has been driven by consumer spending, and Federal Reserve officials have been cajoling business leaders to join the party by hiring employees and buying new equipment and buildings. Businesses have remained reluctant to spend until after the fighting.

Hints of a rebound
Alan Greenspan, chairman of the Federal Reserve, expressed this in his inimitable way in testimony this week before Congress: "Indeed, the heightening of geopolitical tensions has only added to the marked uncertainties that have piled up over the past three years, creating formidable barriers to new investment and thus to a resumption of vigorous expansion of overall economic activity."

Greenspan added that "if these uncertainties diminish considerably in the near term" -- in other words, if we get on with it and win the war handily -- the economy probably will grow more rapidly as business investment picks up.

And if the economy begins to grow more rapidly, interest rates will rise.

Richard DeKaser, chief economist for National City Corp., says war will resolve uncertainties about corporate spending and oil prices. "I believe that on or near the start of hostilities, prospects for the economy will improve and mortgage rates will increase," he says. "I wouldn't advise people to wait until hostilities begin. By then it will be too late."

Mayland won't allow himself to be pinned down with a prediction, but he notes that "a rebound is closer at hand now than in early 1991, when the war broke out then."

As for Greenspan, he says that it's possible -- though not probable -- that the war will reveal that the economy "is still laboring under persisting strains and imbalances that have been misidentified as transitory." In that case, businesses would continue to be wary of hiring and investing, and interest rates would remain stable in a relatively stagnant economy. But he doubts that will happen. Greenspan thinks the economy will rebound, causing rates to rise.


-- Posted: March 14, 2003




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