What Does the Crisis In Ukraine Have to Do With Mortgage Rates in America?

Russian military vehicles on parade in 2010. Source: Wikimedia Commons.

Earlier this week, I came across the following headline: "Mortgage Rates Hold Ground After Ukraine Headlines."

The point of the piece, as the title suggests, was to highlight the paradox that mortgage rates hardly moved today despite reports that Russian troops had crossed the border into Ukraine.

To mortgage professionals and bond traders, this makes sense. Of course mortgage rates would head lower if Russian tanks rolled across the border with Ukraine!

But is it really so obvious? I mean, think about it. Why are mortgage rates tied to otherwise irrelevant geopolitical positioning in Eastern Europe? More specifically, what serves as the transmission device to connect them?

The answer to this requires that we weave together three different things.

First, mortgage rates aren't set by banks; they're set in the bond market -- or, more formally, the market for fixed-income securities.

As you may recall from the financial crisis, once a mortgage is underwritten, it's typically packaged with other home loans into a "mortgage-backed security," which is then sold to institutional investors like insurance companies, pension funds, and university endowments.

Moreover, because almost all newly issued mortgage-backed securities these days are insured by Fannie Mae or Freddie Mac -- in industry lexicon, these are known as "agency" securities -- they carry the same risk as a bond issued by the federal government itself.

In other words, if you have a lot of money to invest but don't want to risk the principal, then an agency mortgage-backed security is a great vehicle to consider.

This brings us to the second thing. In the face of unrest -- be it economic, political, environmental, military, or whatever -- investors have a tendency to abandon risky assets in favor of safe ones.

And what's safer than an agency MBS? Answer: nothing. As a result, when events cause investors to get nervous, they substitute out of things like equities, causing stock prices to fall, and into Treasury bonds and agency MBSes, causing their prices to rise.

We've now arrived at the third and final piece to this puzzle -- that is, the relationship between the price of fixed-income securities like agency MBSes and their yield or interest rate.

Although it seems counterintuitive at first, the price of a fixed-income security and its yield is inversely related. Dig a little deeper, however, and this makes sense. If a $100 bond pays $2 a year in interest, its yield is 2% ($2/$100). But if investors bid the price of that bond up to $150, its yield drops to 1.33% ($2/$150).

And don't forget that the interest rate an MBS pays relates back to the actual mortgages contained therein.

So, to tie everything together: Mortgage rates are set by the price, and thus yield, of mortgage-backed securities. The price of mortgage-backed securities, and particularly those issued by Fannie Mae or Freddie Mac, is a function of market risk -- the higher the risk, the higher the price.

Consequently, because a Russian invasion of Ukraine would be perceived by market participants to increase risk, it would drive the price of mortgage-backed securities higher. And because these prices are inversely correlated to yield, it follows that the interest rate on new mortgages would move lower.

Make sense? I'll be the first to admit, this isn't obvious from the outset. Yet at the same time, while Wall Street may prefer that you think otherwise, this is far from rocket science.

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Read/Post Comments (15) | Recommend This Article (24)

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  • Report this Comment On April 15, 2014, at 9:17 PM, DoctorLewis4 wrote:

    OK. I understand your point but the title to this article is really offensive,

  • Report this Comment On April 16, 2014, at 9:39 AM, Chris57 wrote:

    What, it's bad that Russia to annexed Crimea but it's OK if we invade? There is all together too much BS on this subject being floated by mainstream media outlets.

  • Report this Comment On April 16, 2014, at 11:19 AM, bibom wrote:

    Another drop out from this crisis to help home buyers are sanctions against rich Russians. They will stop buying real estate in USA causing prices to drop a little. More economic sanctions against China etc will make prime real estate affordable for working families.

  • Report this Comment On April 16, 2014, at 12:52 PM, Courtier123 wrote:

    Instead of peace and debt free prosperity, we have ever mounting debt and periodic wars. We as a people are now ruled by a system of Banker owned Mammon that has usurped the mantle of government, disguised itself as our legitimate government, and set about to pauperize and control our people. It is now a centralized, all powerful political apparatus whose main purposes are promoting war, spending the peoples' money, and propagandizing to perpetuate itself in power. Our two large political parties have become its servants, the various departments of government its spending agencies, and the Internal Revenue its collection agency.

    Unknown to the people, it operates in close cooperation with similar apparatuses in other nations. which are also disguised as "governments." Some, we are told, are friends. Some, we are told, are enemies. "Enemies" are built up through international manipulations and used to frighten the American people into going billions of dollars more into debt to the Bankers for "military preparedness," "foreign aid to stop communism," "minority rights," etc. Citizens, deliberately confused by brainwashing propaganda, watch helplessly while our politicians give our food, goods, and money to Banker controlled alien governments under the guise of "better relations" and "easing tensions." Our Banker controlled government takes our finest and bravest sons and sends them into foreign wars with obsolete equipment and inadequate training, where tens of thousands are murdered, and hundreds of thousands are crippled. Other thousands are morally corrupted, addicted to drugs, and infected with venereal and other diseases, which they bring back to the United States. When the "war" is over, we have gained nothing, but we are scores of billions of dollars more in debt to the Bankers, which was the reason for the "war" in the first place!

  • Report this Comment On April 16, 2014, at 1:22 PM, dbtuner wrote:

    Rates would sky rocket over night if the crisis grew out of control such as an attack on a US Warship or US aircraft downed.

  • Report this Comment On April 16, 2014, at 1:42 PM, Ukie26 wrote:

    This article has no respect for real news stay outa ukrainian problems and focus on how your own this is so disrespectful people from Ukraine might think the same of the us

  • Report this Comment On April 16, 2014, at 2:29 PM, GeorgePolitico02 wrote:

    We are flirting with a nuclear war. If we have one, hundreds of millions of people will die, and neither the USA nor Russia will ever recover.

    Unfortunately, (a) the process of international diplomacy, (b) the need for the news media to get attention, (c) the need for political parties to appeal to American nationalism, and (d) the kinds of mercenary calculations discussed in this article all reward increasing the risk without actually going over the edge. However, unless we can change, sooner or later we may well go over the edge.

    I hope that the Russians are wiser, but I seriously doubt it.

  • Report this Comment On April 16, 2014, at 5:32 PM, Joefacc2244 wrote:

    We need a 1960's style ant-war protests in this country. If not, Obama will get us sucked into another stupid war for nothing.

  • Report this Comment On April 16, 2014, at 6:48 PM, mark204 wrote:

    Who to say that Putin will stop with Ukraine? What if he wants to restore the old borders before the 89 collapse?

  • Report this Comment On April 16, 2014, at 7:08 PM, ConsultantOne wrote:

    Well, at least you posted your glib story in the right place. As the founder of The Winkle Institute for Worldwide Economic Stability, I have found that it is greed that causes most of this world's problems.

    I guess your real questions is- Why do Ukrainians' lives matter to the United States as long as a few people that can afford to buy a home in the worst economy since 1930? If I had a nickle for every stupid, irresponsible comment made while I was trying to solve the European Union fiscal crisis (which is well on the way to recovery), thank you, I would be Saint Nickless.

    Motley Fool's columnists should have to go through sensitivity training before they are permitted anywhere near a computer. Were you even sober when you wrote this piece?

    Realistically, for every person lost to war, the economy doesn't change that much, but to compare falling mortgage rates to the value of a life of a sentient being of any kind is wrong.

    If you read this article, Motley Fool apologizes for your wasted time.

  • Report this Comment On April 16, 2014, at 8:04 PM, eddabraham wrote:

    Get these Freddie and Fannie bonds to the homeowners at 1.75% and never worry about this ever causing another housing bubble.

  • Report this Comment On April 16, 2014, at 9:48 PM, volcan357 wrote:

    I understand your logic but what scares me with long term bonds especially ones that pay a low interest rate is inflation. It is hard to believe that eventually all this debt that has been accumulating will not translate into some serious inflation at some point in the future. So instead of providing security instead they might result in a big loss. If we get into some kind of a conflict the government will borrow even more money and make the debt even higher.

  • Report this Comment On April 16, 2014, at 9:48 PM, oldsenior wrote:

    Mortgaged backed securities , it seems to me back when our economy tanked wasn't it these same MBS instruments that became untradeable , nobody could bailout of these investments when the housing market tanked, so many of these mortgages failed due to no due diligence by these mortgage companies, it's amazing what short memories investors have...

  • Report this Comment On April 17, 2014, at 1:21 AM, Joefacc2244 wrote:

    So you're saying American's want Russia to invade Ukraine so that they can pay a higher interest rate on their home loan??? What are you guys smoking??

  • Report this Comment On April 17, 2014, at 7:39 AM, MichaelRN wrote:

    By your rule the title of this article is "in bad taste". It seems to indicate that millions of Americans would be happy due to the pain and suffering of millions of other people just for monetary gain. I find it offensive in a big way on behalf of both the Ukrainian people and America.

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John Maxfield

John is The Motley Fool's senior banking specialist. If you're interested in banking and/or finance, you should follow him on Twitter.

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