A Bumpy Road Ahead?

An editorial in a recent Wall Street Journal raises some interesting and serious issues for our economy in the next several years. Currently, interest rates are at historically low levels. The Federal Reserve has been seeking to keep interest rates low in order to spur recovery. Homeowners have welcomed the low interest rates and rising real estate prices by taking out home equity loans. Many homeowners have taken out one-year floating rate home equity loans that they may find difficult to repay or refinance if interest rates increase.

"Most worrisome is that many owners are essentially borrowing short via one-year floating rate mortgages. These floaters look delicious now with rock bottom rates, but they will present difficulties if rates have climbed when it comes time to adjust mortgage payments." There is very little slack in the system. Down payments have been low, so that many homeowners have little equity in their homes. But this problem may not trouble many lenders. They have sold the mortgages to Fannie and Freddie. Of course, this does not eliminate the risk, but transfers it to a quasi-government agency. Those financial institutions that hold mortgages may find it increasingly difficult to collect the monthly payments and costly to foreclose if loan-to-values have been overly generous.

The editors' conclusion is striking: "Treasury Secretary John Snow, for example, could do worse right now than have his examiners descend on Fannie Mae and Freddie Mac with fine-tooth combs. The simple truth is that today's low interest rates won't continue forever. Forewarned is forearmed."