Back when interest rates plummeted, homeowners with adjustable-rate mortgages ended up saving $150 per month on average, which dramatically reduced their chances of falling behind on their loans.
But that’s not all. The savings also led to more automobile purchases among those borrowers, less credit card debt, and more jobs in their communities, according to researchers at the University of Chicago, Columbia Business School and Fannie Mae.
This goes to show that the Federal Reserve policy that pushed mortgage rates lower all those years ago helped stimulate consumer spending and rev up the economy, just as the Fed had hoped, the researchers said in a working paper for the National Bureau of Economic Research.
The conclusions came after tracking the payment history on 400,000 adjustable rate mortgages and other types of debt owed by the borrowers who took out those mortgages -- including credit card and auto loan debt.
The mortgages had a fixed rate for five years and then adjusted every year thereafter. All of them were issued between January 2003 and July 2007, so they started to reset at a time when interest rates hit historic lows as a result of steps taken by the Fed.
Late into the 2008 financial crisis, the Fed began buying a sizeable chunk of Treasury bonds and mortgage-backed securities. The purchases immediately pushed down interest rates. When the Fed conducted two more rounds of purchases, rates fell even more. Today, they remain low by historical standards.
That’s why the borrowers whose rates adjusted since the Fed policy took effect saw their monthly mortgage payments decline. As a result, their default rates dropped by 40 percent compared to another group of homeowners with similar characteristics whose loans were not adjusting at that time, the study concluded.
With more cash in their pockets, these borrowers felt more confident buying a car. Their chances of purchasing one increased significantly – by 10 percent in relative terms – two years after the rates were reduced.
Those who had high credit card balances used more than 70 percent of the money saved to pay down those debts the first year after their rates reset. The behavior was rational considering that the average rate on a credit card was roughly five times higher than the rate on a mortgage at the time. Whittling down the credit card debt helped people improve their overall credit standing – and certainly helped the credit card companies, the study said.
But it did not generate much consumer spending among those borrowers, said Tomasz Piskorski, one of the study’s authors and an associate professor at Columbia Business School. “That’s one impediment of this policy,” Piskorski said. “If the goal is to stimulate household spending, policy makers might consider tackling the cost of the credit card debt.”
They might also consider having mortgages automatically reset across the board when interest rates fall, Piskorski said. The beauty of automatic resets is that borrowers don’t have to do a thing, and they get the benefits even if they have low credit scores or little equity in their homes (issues that might get in the way of a refinance.)
Similar ideas have been put forth before, most recently in a paper by former Treasury Department official Janice Eberly of Northwestern University and Arvind Krishnamurthy of Stanford University. They suggested that mortgages could be designed to automatically refinance into a lower rate during times of economic crisis. The goal would be to eliminate a borrower’s chances of lapsing into foreclosure and support consumer spending.
In that paper, presented at the Brookings Institution last month, the authors argued that temporarily reducing interest rates for troubled borrowers is a more efficient use of government resources than forgiving some of the mortgage debt. It achieves the same effect at a fraction of the cost because the rate reduction is temporary while the debt-forgiveness is permanent.
(Others disagree, most notably Amir Sufi of the University of Chicago and Atif Mian of Princeton University, who say reducing the mortgage debt of troubled borrowers would have had a huge impact during the crisis years, especially in areas where home prices plunged.)
Speaking of home prices, the study released this week also looked at mortgages by Zip code, comparing areas that have a high concentration of adjustable rate mortgages to areas where there are more fixed-rate mortgages.
The researchers found that the regions with more adjustable-rate loans experienced a faster recovery in home prices, car purchases and employment once the lower interest rates kicked in. When rates adjusted and borrowers paid less on their mortgages, they spent more on the local economy, boosting employment in their area grocery stores and restaurants.
The researchers – including Benjamin J. Keys and Amit Seru of the University of Chicago and Vincent Yao of Fannie Mae – said that while the Fed's lower interest rate policies had limits, it most definitely improved household balance sheets.
“We don’t take a position on whether the federal policy is optimal or not,” Piskorski said. “There’s always the risk of inflation. But the policy did have a meaningful impact on the economy and you have to take that into account going forward.”
The Fed has suggested it would stop its purchases of Treasury bonds and mortgage-backed securities in the near future.