Surge in interest rates could crimp economy

Rising long-term interest rates are making it more expensive for home buyers, corporations and the U.S. government to borrow money, threatening to further stifle an already weak economy.

In just the last two weeks, the rate on a 30-year fixed-rate mortgage has risen to 5.6% from 4.9%, ending a boom in refinancing and working against a budding recovery in the housing market. Rates on corporate borrowing have also risen, making it more expensive for companies to expand. And the government has been forced to pay more to finance its deficit.

Since the beginning of the year, historically low mortgage rates have had a twin benefit for the economy: They have allowed Americans to refinance about $1.5 trillion worth of mortgages, thus lowering monthly payments and leaving homeowners with more money to spend on goods and services. Low rates have also created greater incentive for people to buy homes, despite continuing troubles in the housing market.

The abrupt rise in rates has removed that key stimulant for the economy.

The rise has many causes, some of which reflect good news. As investors have grown more confident about the future, for example, they have become more inclined to put money in risky investments, such as the stock market, rather than lend it to the U.S. government and to government-backed mortgage companies.

But other causes give more reason for worry. Investors around the world are increasingly fearful that Congress and the Obama administration will be unwilling to bring taxes and spending into line in the years ahead. That makes the U.S. government appear to be a riskier borrower, leading those who lend to it to demand higher interest payments.

The Federal Reserve now finds itself in a box. It could try to lower rates by purchasing government debt. It has said it would buy $1.5 trillion in U.S. Treasuries and mortgage-related securities this year to try to stimulate growth.

But doing so probably would only deepen fears that the Fed will print money to fund government deficits in the future. That possibility, although rejected by Fed officials and many mainstream economists, means that expanding purchases might not have the intended effect of lowering rates. It could even drive them up further.

Rates remain very low by historical levels. But the yield on 10-year Treasury notes has risen from 3% in March to almost 4% this week.

A wide variety of other rates are essentially moving in tandem with that rate, including mortgages. That shift has far-reaching implications.

“Households really have no capacity to afford higher rates at this point,” said Scott Anderson, a senior economist at Wells Fargo. “It affects the cost of any long-term borrowing a consumer or business might do, whether it’s auto loans, mortgages or business credit.”

The number of refinance transactions has dropped 62% since early April, according to a survey by the Mortgage Bankers Assn.

Amber Sutton, a Washington resident, was among those poised to benefit from low mortgage rates. She had been considering refinancing her mortgage for weeks. By reducing her rate from its current 5.5% to well under 5%, she would have been able to reduce her monthly payments by about $200 -- money that would have been available to plow into expanding her business, dog day-care Dogtopia.

“I would have put the savings toward opening a new location in one or two years,” Sutton said. Now, with rates higher, refinancing wouldn’t offer her any savings.

“Borrowers who were approved but didn’t lock their rate are just walking away,” said Christopher Cruise, a senior loan officer at GotEHomeLoans in Bethesda, Md. “They could have saved a few hundred dollars a month at last month’s rates, but it makes no sense for them to refinance now.”

So far, home purchase activity has been relatively stable, according to a variety of indicators. But if the higher mortgage rates persist, they could put a damper on a fragile housing market.

“The increase so far has not really been enough to choke off home buying,” said Jay Brinkmann, chief economist at the Mortgage Bankers Assn. He added, though, that “higher rates might lead them to pay a lower price or look for a smaller home.”

Fed leaders have generally viewed the rise in government borrowing rates as benign, reflecting money flooding away from the safety of Treasury bonds and into riskier investments. That, in the view of Fed officials, creates a self-correcting mechanism. If rates rise so much as to choke off economic growth, the resulting weakness in the economy will drive rates back down again.

Officials are more concerned about widespread discussion of the idea that the Fed will buy up Treasury bonds far into the future in a manner that generates high inflation.

Lawmakers and television commentators alike have broached that possibility, called “monetizing the debt,” with increasing frequency in recent weeks.

“The Federal Reserve will not monetize the debt,” Fed Chairman Ben S. Bernanke said last week.

Nonetheless, the mere existence of that chatter could make the Fed less inclined to ramp up its asset purchases at its next rate-setting meeting, scheduled for June 23 and 24.