The Bernanke Put: The Implied Protection of Mortgage Interest Rates

The Federal Reserve under Ben Bernanke is continuing the policy of fostering moral hazard through implied guarantees. The Bernanke Put applies not just to the stock market, but directly to the home mortgage market as well.

Today's featured property is a delusional flipper lowering price to find the market.

Irvine Home Address … 14512 LARCH Irvine, CA 92606

Resale Home Price …… $775,000


You don't tug on Superman's cape

You don't spit into the wind

You don't pull the mask of the old Lone Ranger

And you don't mess around with Jim

Jim Croce — You Don't Mess Around With Jim

Maybe that song should be, "You Don't Mess Around with Ben." Arguably, Ben Bernanke is a powerful man in Washington because decisions he makes have major impact on citizen's lives. His most consequential recent decisions concern the Federal Reserve's program of buying agency debt and what under what circumstances the program would be continued.

Analyst: Pressure Will Build on Fed To Extend Mortgage Program

By Nick Timiraos

With the Federal Reserve set to wind down its purchases of mortgage-backed securities in a little more than 30 days, there’s growing uncertainty about what will happen to mortgage rates. Already, rates bumped up last week after the Fed said it would raise the discount rate by quarter point to 0.75% last Thursday.

But the elephant in the room is the Fed’s planned exit from the mortgage market, and analysts expect rates to rise by anywhere from a quarter-point to a full percentage point or more. Bob Eisenbeis, the chief economist at Cumberland Advisors, has a provocative commentary piece on Wednesday morning arguing that there’s a growing chance that the Fed will have to come back to buy mortgage-backed securities because of ongoing concerns over the fragility of the housing market. Two indicators out Wednesday morning underscore that softness: the MBA reported that loan applications for home purchases was at a 12-year-low last week, and new home sales plunged 11.2% in January.

“What we expect is that toward the end of the first quarter political pressure on the Fed will increase from both [Fannie and Freddie] and Congress to temporarily extend the program because of the concern about hurting a still struggling housing and mortgage markets,” Mr. Eisenbeis writes. “But if this fails to persuade the FOMC to change its mind, the program stops, and interest rates jump up significantly, then the Fed itself will decide that the risks of another downturn are too great, and the program will be restarted. In either case, the most likely outcome is that there will be some form of extension of the MBS purchase program.”

In testimony on Wednesday, Federal Reserve Chairman Ben Bernanke said that while they anticipate ending the purchase program by the end of March, the Fed “will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial markets.” The statement seems to leave open the possibility for an extension.

Leave open the possibility? Does anyone believe the government will exit the mortgage market on schedule? Will they exit at all? Leaving open the possibility is implicit backing to markets. The Federal Reserve will intervene if problems become too big.

What is the threshold of the Bernanke Put?

So what would it take to have the Federal Reserve restart buying agency paper again? Some analysts have suggested that current interest rates a full point below market value due to market manipulation. An increase of one percentage point would reduce future loan balances by 10% and take prices down commensurately.

My guess is that the Federal Reserve will not permit interest rates from moving 100 basis points or 1% from current levels, and they will maintain this 1% backstop over the next several years. Interest rates will be allowed to rise during this time, but only in proportion to increasing incomes so that house price levels are maintained.

Don't spit into the wind.

Basically, the Fed determined further price declines would wipe out the remnant capital in our banking system; therefore artificially low interest rates — a necessity to support artificially high prices — will remain in place to prevent significant future price declines. You can't fight City Hall. With an unlimited balance sheet an a direct financial conduit to the housing market through the conservatorship of the GSEs, our government in cooperation with the Fed can make financing available and inexpensive and inflate a housing bubble as large as they wish.

Will this policy be effective? I have my doubts, particularly at the high end where denial rules and high-end house sellers lower their sights only when they must, and anyone selling mansion can expect to wait 3 years. Supply is also artificially low due to the lack of discretionary sellers and an abundance of shadow inventory and unlisted foreclosures. The instability of the cartel should result in slowly declining prices, but anything is possible.

If Fed policy is successful, prices will behave like the ice scenario for the post Fire and Ice:

How fast can interest rates rise?

In the post Real Estate's Lost Decade we explored how quickly interest rates could rise if wage growth compensated for the lost borrowing power, and the results are in the chart below:

As you can see, interest rates can only rise about 35 basis points (0.35%) per year or prices will fall.

Calculating the Bernanke Put

Using the above chart as a basis and adjusting for actual performance, I developed the chart below. Mortgage interest rates from 2006-2009 are actual, and the maximum allowable increase to hold pricing is projected from 2010-2018. Further, if we assume 1% is a reasonable buffer from point-in-time interest rates, the red line in the drawing represents the interest rate threshold where I believe the Federal Reserve would step in and begin buying agency debt once more.

If mortgage interest rates rise above the red line, house prices will drop significantly, and both the Federal Reserve and the US taxpayer will absorb significant losses on the numerous loans they have purchased and insured over the last few years; therefore, the Federal Reserve will hold mortgage interest rates below the red line with the Bernanke Put.

Central banking puts and moral hazard

The discussion above reflects what I believe to be the most likely course of action for the Federal Reserve with respect to its purchase of agency debt to support the housing market. This wrongheaded policy will foster greater levels of moral hazard. How many idiotic bulls have you encountered that base their bullishness on the unprecedented level of government intervention in the markets? How much speculation is occurring due to buyer's beliefs in perpetual government supports? How is that a good thing?

Irvine Home Address … 14512 LARCH Irvine, CA 92606

Home Purchase Price … $570,200

Home Purchase Date …. 11/18/2009

Net Gain (Loss) ………. $158,300

Percent Change ………. 35.9%

Annual Appreciation … 95.7%

Cost of Ownership


$775,000 ………. Asking Price

$155,000 ………. 20% Down Conventional

5.12% …………… Mortgage Interest Rate

$620,000 ………. 30-Year Mortgage

$162,671 ………. Income Requirement

$3,374 ………. Monthly Mortgage Payment

$672 ………. Property Tax

$0 ………. Special Taxes and Levies (Mello Roos)

$65 ………. Homeowners Insurance

$75 ………. Homeowners Association Fees


$4,185 ………. Monthly Cash Outlays

-$829 ………. Tax Savings (% of Interest and Property Tax)

-$729 ………. Equity Hidden in Payment

$312 ………. Lost Income to Down Payment (net of taxes)

$97 ………. Maintenance and Replacement Reserves


$3,036 ………. Monthly Cost of Ownership

Cash Acquisition Demands


$7,750 ………. Furnishing and Move In @1%

$7,750 ………. Closing Costs @1%

$6,200 ………… Interest Points

$155,000 ………. Down Payment


$176,700 ………. Total Cash Costs

$46,500 ………… Emergency Cash Reserves


$223,200 ………. Total Savings Needed

Property Details for 14512 LARCH Irvine, CA 92606


4 Beds

3 full 1 part baths Baths

2,700 sq ft Home Size

($287 / sq ft)

5,005 sq ft Lot Size

Year Built 1971

47 Days on Market

MLS Number S601097

Single Family, Residential Property Type

Walnut Community

Tract Cp



HIGHLY SOUGHT AFTER AND DESIRABLE? Is that redundant and repeated?

Property History for 14512 LARCH

Date Price
Feb 19, 2010 $775,000
Jan 22, 2010 $785,000
Jan 14, 2010 $810,000
Jan 09, 2010 $835,000

$835,000? WTF? At $775,000 it is still too high for OMG. This flipper is holding out for a 35% gain. Good luck with that.

38 thoughts on “The Bernanke Put: The Implied Protection of Mortgage Interest Rates

  1. winstongator

    Keeping interest rates low in the face of falling/stabilizing prices is one thing, keeping them low in the face of rapid increases (G’span) is another. Your armageddon scenario would be much worse than the other two because of the collateral damage, unemployment, actual destruction of housing stock in disgruntled foreclosures, etc.

    BigBen also is dealing with the nation, not just Irvine. In SEFla, prices are pretty much as 2000-2003 levels depending on the area. In many places, the bubble has popped and they are in recovery mode.

    Purchase mortgage apps are down because purchases are down, no the other way around. When the tax credit was expiring in Nov, a huge amount of demand was pulled forward, demand that’s not around now. I always wondered that if a super option-arm with no documentation needed didn’t get all the on-the-fence home buyers into the market, why would an 8k credit do it? There aren’t many renters waiting to move in and buy (in most of the country, Irvine prices still have some room to fall). Combine that with people’s low interest rate refi’s, and you will have low existing home sales for a while, and even lower once rates increase.

    I was talking to a mortgage banker at a big, but not too-big-to-fail bank that has weathered the storm about as good as any. He mentioned that after the 2003 wave of refi’s only a small fraction of their loan book was more than a year or so old – 10% is the number the pops to my head. Any idea now at the average age of a mortgage? It really is like a reset button has been hit…twice in the naughties. Problem is, we don’t have another shot at a reset.

  2. Planet Reality

    If you want to understand where interest rates can and will be take a look at Japan.

    As Japanese debt increased dramatically over a 20 year period, interest rates on debt kept getting lower and lower.

    Believe it or not, the US has plenty of room to ramp up debt when compared to Japan. Expect this to drag on for a long time with low interest rates for debt probably getting lower.

    1. Chuck Ponzi

      Planet Reality,

      I agree, but am very conflicted. The reason that Japan was able to take on this level of debt is because they have such a strong saving class, which made their government debt a better risk.

      We have household and government deficits to the sky. We are a much bigger risk than Japan. We also spend like drunken sailors. I wouldn’t lend money to us at these rates; I can only assume this is debt monetization; trying to force inflation with a combo monetary/fiscal one-two punch. Any other theories?

      1. IrvineRenter

        “I can only assume this is debt monetization; trying to force inflation with a combo monetary/fiscal one-two punch. Any other theories?”

        That is how I see it. Bernanke as an academic wrote about this scenario, and so far, he is doing what he said he would as an academic. He will print money in any form he can — mortgages were expedient — until inflation starts, and then we can only hope he turns the printing press off.

        1. Planet Reality

          Chuck and IR,

          The best part is that the US can have it both ways.

          The US can print all the money it wants and has plenty of savers for all the debt the US wants. You didn’t think the savers had to live in the US did you? Ultimately this will end badly but given the current state of debt to GDP versus the rest of the world I am confident it can continue 50 to 100+ years. It’s a long slow burn to the collapse.

  3. IrvineRenter

    Is it the lighting in the photo, or are the cabinets mismatched in the kitchen? If this is a renovation warranting a 35% increase in value, I don’t see it.

    1. Long Beach Renter

      I think they’re mismatched. But the photography is definitely weird— it makes it look like there isn’t a right angle in the whole house. I felt almost dizzy looking at these pictures.

  4. Planet Reality

    When you take the time to ponder the consequences of mortgage rates at 6 – 10%, it’s easy to conclude rates will stay low.

    I predict a flatter ice scenario for Irvine, but a deeper ice scenario for most of Orange County. Irvine might even get back to peak pricing faster.

  5. Stock Investor

    “The Federal Reserve will intervene if problems become too big.”

    There are limits to government’s power. High unemployment, budget deficit and upcoming inflation may be more serious issues than housing market.

    1. matt138

      Free market forces will eventually limit this BS. I hope it comes sooner than later. I embrace viability. It seems everyone else justifies playing musical chairs forever to avoid the inevitable. Children.

  6. wheresthebeef

    That is one ugly house, it looks like it started as a one story rancher and then a box was added on top of the garage. Anybody who pays almost 800K for this is completely insane.

    Regarding interest rates, I’m sure Big Ben and the other stooges already have their memos written for extending the MBS purchase program. This current economy won’t function with higher rates, it barely functions as is. That’s ok, we’ll just have the next few generations clean up this collosal mess.

    1. IrvineRenter

      Yes, the data is accurate.

      “Inventory has dropped in these markets, suggesting demand is up, and prices in California rose overall from January 2009 to August 2009.”

      The mistake is obvious in this sentence; inventory dropped but since volume is down 20% below historic norms, demand is clearly not up.

      1. freedomCM

        While median price is up, that reflects the sales mix.

        Case-Shiller is flat.

        I guess flat is the new “up”?

    2. LC

      I know that I have gotten flack before for mentioning Hemet. But that was when I thought that prices for almost new 3000 sq ft house around $187k were simply impossible to ignore by the good people of Irvine. Well, guess what? These prices are down to $99k.

      1. lowrydr310

        Now is a great time to buy investment homes in Hemet! For less than the price of a downpayment on an Irvine condo, you could own a home outright in Hemet and rent it out should you decide not to live there! Positive cashflow!

        A good friend of mine owns two rental homes in Hemet, and you’d never guess, but it’s not easy finding quality reliable renters out that way. I happen to like the area and wouldn’t mind living there, but there are no jobs available in my line of work, and my wife’s not fond of the desert.

        1. NOT

          lowrydr310, I love the contradictions between the first par above and the second:
          Par 1: Great time to invest
          Par 2: No jobs, hard to find renters, not fond of the desert

          hmmmmm….. Makes one think it may not be a great time to invest as one’s “investment” may sit empty. Sort of takes away from “Positive cashflow!”

          1. lowrydr310

            Sarcasm my friend. I guess it’s not as obvious in my writing as I thought.

            Sarcasm in the first paragraph.
            Seriousness in the second. My friend and his parents own several homes in Hemet that are rented out. Some have worked out, while others haven’t. Overall I don’t think it’s worth the effort as they’re always fixing something, trying to rent out, collecting the rent, etc. Ten years ago it was relatively stable; now not so much.

          2. winstongator

            It was obvious to me :). When an ! comes after ‘great time to invest’ always have an eye out for sarcasm.

      2. NOT

        So, if you are talking about the houses that say “Investor Cash Sale!! Home can not be occupied per the City of Hemet. Former Model Home in Peppertree Development. 5 Models being sold together or separate. All Buyers must sign disclosures (see supplements) prior to offer submissions. Properties are in a senior retirement community. ”

        I am sure that does not count.

  7. Soylent Green Is People

    The MBS extension whispers started literally hours after the Fed gave a March termination date for the program. Never consider the loud headlines, but listed for the still, soft voices saying otherwise.

    As long as your not the only one hearing those said same voices, of course…. Did I just say that out loud?

    My .02c

    Soylent Green Is People.

  8. Alan

    “How much speculation is occurring due to buyer’s beliefs in perpetual government supports?”

    If the government is going to support the market for the next several years, doesn’t this open up a window of opportunity for flippers and speculators to do their thing? They just have to make a guess about how much and how long the support will be there, and try to get out before a significant rate rise.

  9. quailoverthehill

    Is there any corner of Irvine that a Realtard won’t call “highly sought-after,” “desireable” or “exclusive”? College Park is bounded on the south by the Amtrak and Metrolink tracks (“You’ll get used to it”) and the houses are approaching 40 years old, which, in Irvine, is almost prehistoric. What IS highly desireable is the near-absence of HOA fees and no Mello-Roos.

  10. Soylent Green Is People

    The HARP program (Home Affordable Refinance Program) has been extended to 2011 as per recent press release. If it’s been extended AND rate are suppoosed to go up, what good is extending the program. A sign, IMHO, that the Fed will continue MBS purchases.

    My .02c

    Soylent Green Is People.

  11. tonye

    I love Jim Croce’s songwriting and singing.

    Actually, when it comes to Croce’s songs, the best fit to Bernanke would be Bad Leroy Brown, after all they’re both GAMBLERS…

    And it’s bad, bad Leroy Brown
    The baddest man in the whole damn town
    Badder than old King Kong
    And meaner than a junkyard dog

    Now Leroy he a GAMBLER
    And he like his fancy clothes
    And he like to wave his diamond rings
    In front of everybody’s nose
    He got a custom Continental
    He got an Eldorado too
    He got a 32 gun in his pocket for fun
    He got a razor in his shoe

    Great songs.

  12. HydroCabron

    A title search would turn up a previous owner, one D. Downer.

    Based on the haunting photographs, this is a home is a place for depression and regret; for learning afresh each day that hell is an endless conversation with oneself. A negative force sucks you into each image, beckoning your psyche into a closed loop of self-absorption and alienation.

    The non-rectilinear photo of the façade suggests that the house itself is rearing up in preparation to strike at the viewer. The patio photo beckons you toward a dark place, uncertain only in its particulars, but not in its finality. The reticulated kitchen flooring places you in a chessboard worthy of Dali: the pieces may meet at right angles in the foreground, but as they move away, who’s to say what at what angle they ever met?

    The remaining photos of bedroom interiors are the final, decisive clanging shut of the prison door of depression. Each has just enough light from a far-distant window to allow one to contemplate the futility of the treadmill on which we march to nowhere but death. Perfect rooms in which to awaken each morning, as Philip Larkin:

    I work all day, and get half drunk at night.
    Waking at four to soundless dark, I stare.
    In time the curtain edges will grow light.
    Till then I see what’s really always there:
    Unresting death, a whole day nearer now,
    Making all thought impossible but how
    And where and when I shall myself die.

    And so it stays just on the edge of vision,
    A small unfocused blur, a standing chill
    That slows each impulse down to indecision
    Most things may never happen: this one will,
    And realisation of it rages out
    In furnace fear when we are caught without
    People or drink. Courage is no good:
    It means not scaring others. Being brave
    Lets no-one off the grave.
    Death is no different whined at than withstood.

    Or Auden:

    The glacier knocks in the cupboard,
    The desert sighs in the bed,
    And the crack in the tea-cup opens
    A lane to the land of the dead.

  13. avobserver

    I wish Bernanke had an option not to stop buying RMBS …
    It should be obvious to many by now that the whole US (as well as most of the nations in the developed world) economy over the last 20 years resembles nothing but a house of cards – economic prosperity/expansion and low unemployment were built on fast growth in consumption which was in turn built on easy credit/debt and wealth effect induced by appreciation of asset price, which was in turn built on expansion of bank lending, which was in turn built on rapid house price appreciation that support the underlying securitized debt, which in turn was supported by Fed’s low interest rate policy at the very bottom. Fed’s 0% rate and QE (buying MBS and Treasury) is about the only thin layer of glue that holds the house of cards together (at least for the time being). Remove the prop the whole thing collapses – not just house prices, but the entire economy.
    The thing about a Ponzi scheme is that once it is set in motion there is no turning back. It is strictly a one way street. You need to keep going by increasing the bet but the moment you think about reversing the course, game is over. In the next several years Bernanke will have no choice but to up the ante every time the previous stimulant begins to wear off. Not only will helicopter Ben not stop buying MBS, he is far more likely to buy ever larger quantity of MBS down the road to keep this Ponzi scheme going. If Japan experience is of any indication, it won’t be far-fetched to envision the US mortgage rate to eventually slide down to 2-3% range. As more and more demand gets pulled forward it will take increasingly larger incentives to boost “affordability” and entice people to buy. But buyers will soon figure this out and opt to wait for even lower rates or sweeter deals.
    When subprime loans imploded in 2007 we probably all thought that was the end of the whole Ponzi scheme. But as it turned out housing correction was only a road bump for the schemers. Central banks around the world have far more chips to dispense to get the game going than I had ever imagined. Here at home Bernanke should keep the re-inflating going for at least another 3-4 years. With USD as the world reserve currency Fed is free to monetize debt. So just relax, go get yourself some popcorns, find a good seat, and enjoy the show… it amazes me just how any society built on saving, sound investment and productive innovation, would one day mutate into something that’s all about mindless consumption and wild financial chicanery.

  14. awgee

    Ben is between a rock and a hard place, but we do not know if he sees it. If he allows free market interest rates to rise, as they would without Fed intervention, the US treasury and all civic issuers of debt would not be able to roll over their present paper or be able to pay the interest on their debt. The US federal government alone must roll over $5 tril in the next 18 months.

    China has already started selling their US paper and if Ben does not allow interest rates to rise, they will sell much more, and Japan may sell theirs, causing massive inflation and a rise in interest rates.

    There is no where for Ben to go or anything for him to do. Toast

    1. Muzie

      Ben can’t see he’s between a rock and a hard place, but random commenters on a blog are right there on the pulse of the world economy?

      Puuulease. Sometimes the level of arrogance around here is staggering.

      I could believe Bernanke is deceitful, somewhat conniving, and with a less-than-completely-fleshed-out-plan; then again most people seem pretty short on solutions to fix the problem that don’t involve draconians measures that would get any president in office voted out in a second.

      But I don’t think the man is dumb. He may have his vested interests, yet so do many people around here nowadays.

          1. Muzie

            It matters very little that you were more right or wrong.

            It matters if you think with all your worldly economic experience, you think you would have the knowledge, skills and connections required to replace him and succeed in setting an entire country towards a better future path than he has.

            From my point of view of reading passing anonymous commenters on a blog, that seems like a pretty preposterous proposition.

      1. avobserver

        A pedigree neoliberal thinker like Bernanke is a prisoner of his own rigid doctrine. Given the choice between reality and his plutonic theories he would choose the latter without blinking his eyes. How else would you explain the fact that he completely missed the housing bubble back in 2005 when many “random” and “arrogant” blog commenters saw it coming?

        What Bernanke thinks probably mattered a lot more back in 2001, when Fed still had the chance to nip this Ponzi scheme in its bud. But fast forward to 2010 – he now has no alternative but to keep the scheme going at all cost. Any time they hesitated (as in Lehman Brothers episode) they got a nice foretaste of what is come. Face it – we have long passed the point where our policy makers still have the option to make any meaningful changes.

        As I said a Ponzi scheme is a one way street. We either choose to stop, crash and burn now, which is politically unacceptable, or keep it going until the inevitable bigger crash and burn in the future when the scheme can no longer go on.

  15. awgee

    Oh gosh, and that is not even considering the trillions in interest rate swaps that go boom when interest rates rise.

    1. matt138

      It amazes me the number of people who feel the gov/fed has absolute control over interest rates. They don’t.

  16. IR Fan

    I really like the monthly cost analysis. In the short term, I’d probably exclude the equity hidden in payment (if I assume that housing values stay relatively flat and someone has to pay over $50K in transaction costs to sell the house in 6 years, they’ll barely break even). So would the rental parity of this property be $3,036 + $729 = $3,765?

Comments are closed.