Will the Fed Raise Mortgage Rates?

We hear about the Federal Reserve every day but few people know that the Fed is actually a business of some sort, one with $2.9 trillion in assets and $90.6 billion in profits.

That's right. The Fed has bigger annual profits than Apple ($41.7 billion) or Google ($10.7 billion). Combined.

So how does this happen? And are Fed profits good or bad for mortgage borrowers?

How the Fed Conducts Business

I say that the Fed is a business of "some sort" because there isn't anything quite like it. While businesses generally worry about interest rates, the Fed simply sets several important benchmarks, including:

The discount rate -- the rate changed to commercial banks and others with access to the "discount" window -- is now at .75 percent.

The Federal Funds rate -- the rate lenders charge one another for overnight borrowing -- it now hovers between 0.0 percent and .25 percent.

The Fed can also manipulate the marketplace by deciding to buy or not buy certain forms of securities. For example, in September it decided to buy additional mortgage-backed securities at the rate of $40 billion a month. Such purchases hold-down mortgage rates. To be specific, Federal Reserve Governor Jeremy C. Stein says mortgage rates are about .2 percent lower than they otherwise might be because of the Fed purchases.

The Fed Is not a Non-profit

According to its latest annual report, the Fed earned profits of $90.6 billion in 2012 (up from $78.5 billion in 2011) and paid out $88.4 billion to the US Treasury (a big increase from the $75.4 billion paid to Uncle Sam in 2011).

How the Fed got these numbers is not entirely clear, because among its other extraordinary powers the Fed can create its own accounting rules.

"Accounting principles for entities with the unique powers and responsibilities of the nation’s central bank have not been formulated by accounting standard-setting bodies. The Board of Governors has developed specialized accounting principles and practices that it considers to be appropriate for the nature and function of a central bank."

Given that mortgage rates today are at remarkable lows, we can argue that Fed policies are working. We can also say, however, that assets worth trillions of dollars have been devalued by the Fed's actions. Today, for example, a one-year certificate of deposit pays out about .65 percent. That means if you have saved all your life and now have certificates of deposit worth $1 million, your interest payment will amount to $542 a month.

When Will the Fed Raise Interest Rates?

The Fed's rate policies have pushed interest rates to record lows, something known generally as ZIRP -- the "zero interest rate policy." That's great for FHA mortgages and other forms of real estate financing -- and something mortgage borrowers should take advantage of -- but the very same policy hurts savers and retirees. How much longer will the Fed policies continue? No one knows, but when they change -- and they will change -- it's easy to imagine that interest rates will rise once again.

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