For better or for worse, the Federal Reserve has been trying to drive rates down in the hopes of bringing mortgage rates down with it. It worked briefly in November and December, but now it appears that the anticipated massive stimulus package and the massive borrowing it will entail is resulting in some "crowding out" in the private sector. The result? Higher mortgage rates and fewer mortgage applications.

http://money.cnn.com/2009/01/28/real_estate/mortgage_applications.reut/index.htm

Applications for U.S. home mortgages cratered to levels not seen since November last week as rates held stubbornly above record lows engineered by the Federal Reserve earlier this month, according to data from an industry group on Wednesday...

Rising U.S. government borrowing to pay for financial bailouts and expected stimulus to stave off recession have begun to increase Treasury yields, offsetting Fed efforts to drive mortgage rates lower, analysts said. Benchmark 10-year Treasury yields, which help govern mortgage rates, have climbed nearly a half-percentage point since late December to 2.53%.

The Fed's plans to lower home borrowing rates this year with purchases of up to $600 billion in mortgage-related securities had resulted in a spike in applications, mostly for homeowners seeking to refinance loans. Lower rates boosted affordability on homes, whose prices nationally have fallen more than 25%, to 2004 levels, according to Standard & Poor's/Case-Shiller indexes.

Essentially the increased demand for borrowed dollars by the government is causing interest rates across the economy to increase--including mortgage rates. So even as the Federal Reserve tries to drive down borrowing costs to stimulate the economy, the deficit spending of the federal government is having an opposite effect on the lending market.

Many believe that the underlying problem right now is housing prices. Inasmuch as there was a housing bubble, prices have to deflate. But in order for the housing market to eventually stabilize, people need to be able to buy them. If mortgage rates are increasing due to the government borrowing so much money, that's going to make it harder for people to be able to afford to buy a home which will tend to drive home prices even lower.

So the stimulus package hasn't even passed yet but we're already seeing the first effects in the economy: Higher mortgage rates which will further drive down home prices, which will lead to more foreclosures, which will lead to less wealth and spending, which will lead to fewer jobs, which will provoke liberals to call for more government spending, and the cycle repeats itself.

A trillion dollars and what do we get? Higher interest rates and lower home prices.