Historic bailout, huge efforts to make home l…

Amidst all the $250 billion bailout hoopla, and the previous news that the government will buy up both whole loansand Mortgage Backed Securities, in an effort to drive financing costs DOWN, something interesting is going on — and Idon’t see many people talking about it. Home mortgage rates aren’t falling. They’re going UP.

The average rate on a 30-year fixed mortgage jumped to 6.47% in the week of October 10, according to the MortgageBankers Association. That was up from 5.98% a week earlier and just shy of the August high (6.58%, itself the highestin more than a year).

How can rates be going up when the economy is tanking and the government is throwing everything it can at the bankingsector and credit markets? Because bond investors are dumping bonds – and when bondPRICES fall, bond YIELDS (interest rates) rise.

Why are those investors selling? Well, we just learned that the budget deficit soared to $454.8 billion in fiscal 2008,which ended September 30. That was more than double the $161.5 billion deficit in 2007 and the highest in the historyof the country. Thanks to all the fresh bailout programs, the deficit will likely surge by a few hundred billion MOREdollars in fiscal 2009.

But no one in Washington has shown any willingness to raise taxes to pay for these bailout programs. And there’s no apile of money just sitting around in the U.S. Treasury to fund them, either. We’re a net debtor nation. We’re going tohave to borrow hundreds of billions of dollars to make good on all of our promises.

That means a mammoth flood of Treasury debt is going to wash over the market in the coming year or two. Bond tradersknow that all of that bond supply will overwhelm bond demand. So they’re not sticking around. They’re selling bondsNOW, driving prices down and rates up.

Long bond futures have plunged from an intraday high of 124 23/32 in mid-September to 113-and-change now – a whopping11-point decline. Ten-year Treasury yields have jumped from 3.39% to around 4.10%.

Bottom line: The government would like everyone to think it can just waive a magic wand, drive mortgage rates down,save the banking sector, and return us to the happy-go-lucky, reckless lending days of 2005. But it can’t. There is nofree lunch. Indeed, instead of driving financing costs down, the bailout announcements are actually helping drive keyfinancing rates (like 30-year mortgages) up!

If there is a bright side out there, it’s that LIBOR rates are nudging lower. Three-month LIBOR was fixed at 4.55% thismorning, for instance, vs. an October 10 high of 4.82%. Overnight LIBOR is much closer to the federal funds rate aswell — 2.14% vs. a FF target of 1.5% (a spread of 64 basis points). That compares to a spread of 488 basis points asof September 30.

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