Alan Greenspan, the former U.S. Federal Reserve chairman and still a voice to be heeded, has warned recently that the U.S. Economy may be headed for a recession.

As previously noted here at Rate Comps, the economy in 2007 is expected to grow at its slowest pace since 2002, and Greenspan has indicated that this is a fairly clear indication of the end of the peak in the business cycle. He said that he expects the downturn to begin in late 2007 or possibly 2008, which is in line with most economic forecasters. For those who hear the “R” word and panic, it may be a good idea to understand exactly what a recession is, i.e. - two or more quarters of negative growth in Gross Domestic Product (GDP). Note: others argue that a recession is a few months of negative growth, but since I learned the former definition in economics classes, I’m sticking to it.

The negative effects of a recession are typically reduced employment and corporate profits, but the effects tend to trickle down (pardon the usage) from the broader economy and large corporations to even middle class folks, who typically have investments and retirement savings wrapped up in mutual funds and company stocks that decline in value during recessionary periods.

Perhaps more importantly, however, is the fact that Greenspan still worries about the U.S. budget deficit, despite the fact that in 2006 it actually fell to $247.7 billion. While that figure is the lowest it’s been in four years, it is still a staggering figure. To give a brief summatin of the negative effects of budget deficits, think about it in this way - mortgage rates tend to follow very specific investment vehicles because those institutions that make investments in mortgage-backed securities can and will invest elsewhere if it is advantageous to do so. In short, in order for mortgages to be made available, the rates must be high enough to garner investment dollars. If the rates of 10-year Treasury bonds go up, for instance, then the 30-year fixed rate mortgage rates will also increase.

What would cause the 10-year T-bonds to increase? Well, when one considers that T-bonds are sold by the government to finance its budget deficits, it doesn’t take much to realize what increased government demand for funds will do to rates. That’s right - they’ll go up…and mortgage rates will follow (all other things being equal). There are, of course, other factors that determine mortgage rates, and the previous post I made about an economic downturn keeping rates steady (or forcing them down) still holds true. However, this is an admittedly simple economic analysis and one must keep in mind that the number of factors determining the overall health of the U.S. economy, as well as mortgage rates, are too numerous to accurately consider.

Tags: 10 year treasury bonds, alan greenspan, budget deficits, business cycle, corporate profits, federal reserve chairman, mortgage backed securities, mortgage rates, recession, retirement savings, trickle down

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