Why does the elimination of the 30 year bond free up money for consumers? (November 5, 2001)
One of the problems with mortgage rates not falling (the yield curve too steep) is that the long bond was not falling along with the 10 year treasury. By eliminating the 30 year (the U.S. has done this two other times) as a form of treasury funding, the long end represented by the 30 year is eliminated. That allows rates to be more closely tied to the 10 year. Additionally, the Treasury's announcement impacted supply and demand. The long bond became more scarce and thus limited supply drove the price higher and the yield lower. The long bond rallied over 5 points on the announcement and has been adding to the gains. That reduces the disparity between the 10 and 30 year, pushing that yield curve down. That will drive mortgage rates lower, down below the last major refinancing prices back in 1998. That will set off another round of refinancing. Refinancing at lower rates releases equity from homes and it also frees up more monthly disposable income because payments are lower (if not equity is taken out). Past trends show most of that freed money is spent, not saved. Thus there is more money available and most is spent. This was a very shrewd move that gives a lot of short term economic stimulus. There is risk that the short term rates spike in the future and that would hurt the government as it would be using the short end (no more 30 year) to fund its operations.
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