Mortgage rates are beside the point. That may come as a surprise to members of the Federal Reserve. But then again, probably not.

The Fed’s third round of fiscal stimulus announced earlier this month differs from previous rounds in that it directly targets the housing market in an effort to create a domino effect that will ultimately create jobs and lift the broader economy.

Specifically, the central bank said it will start purchasing $40 billion in mortgage-backed securities each month, an open-ended policy designed to keep mortgage rates low and perhaps push them even lower.

But how much lower can they go? On Tuesday the national average for a 30-year fixed rate mortgage stood at an all-time low of 3.49%, according to mortgage servicer Freddie Mac. A 15-year mortgage can be had at 2.77%, also an all-time low.

Leif Thomsen, founder and chief executive of Walpole, Mass.-based home-loan lender Mortgage Master Inc., said it doesn’t really matter anymore how much lower mortgage rates fall.

“It has nothing to do with the rates,” Thomsen said. “They’re perfectly fine where they are.”

What needs to change, he said, are lending guidelines that remain too strict for many potential homeowners who might otherwise be in a position to take advantage of the historically low rates and vast surplus of available homes.

“It has nothing to do with the rates. They’re perfectly fine where they are.”

- Leif Thomsen, Mortgage Master Inc.

Another thing that needs to change, according to Thomsen, is the status of millions of home owners whose mortgages are under water, meaning the amount they owe on their loan is greater than the value of their home.

Housing is the Right Target

Regardless of where mortgage rates go under the Fed’s newest round of quantitative easing, Thomsen said the central bank was right to target the housing industry because of the sector’s broad reach across the economy.

“That’s where we need to focus. Housing is such a huge percentage of GDP. When someone buys a new home, they’re not just buying a home. So much of the economy is tied to the housing industry,” he said.

In speeches and comments made after the new stimulus was announced on Sept. 13, Fed policy makers have suggested the latest move was an effort to maintain and hopefully build momentum for recent gains achieved in the housing market.

If mortgage rates fall a bit lower, that’s fine, the Fed members have said. But the real goal is to create a solid foundation beneath the fledgling recovery, one that generates increased demand and ultimately stimulates job creation in the myriad areas of the economy directly tied to housing – construction, retail, lending, etc.

There’s growing evidence to support that premise.

The latest S&P /Case Schiller Home Price Index, which gauges home values in 20 U.S. cities, rose 1.6% month-over-month in July, slightly lower than economists had hoped for but a gain nevertheless. It was the third straight month prices rose in all 20 cities.

Anthony Sanders, a finance professor at George Mason University, agrees that mortgage rates are neither the problem nor the solution.

“Unless (mortgage servicers) Fannie Mae and Freddie Mac loosen up some of their credit standards or the banks get back in the game for their own portfolios, the Fed could lower mortgage rates to minus 10% and it won’t stimulate a housing recovery. The problem really is that credit is too tight and money velocity is too low,” Sanders said.

Money velocity, a fairly arcane gauge of economic activity, is defined by the Fed as “the rate of turnover in the money supply,” or “the number of times one dollar is used to purchase final goods and services included in the GDP.”

Fiscal Cliff Could Kill Momentum

If the rate of velocity is swift it’s good for the economy. It means transactions are taking place and money is exchanging hands. If the velocity rate is slow it’s bad for the economy because consumers and institutions (banks and corporations) are holding on to money and therefore impeding transactions.

The latter is currently the case, and it’s getting worse.

According to the Fed, which tracks money velocity, the measure fell again in the second quarter of 2012 and has hit its lowest level in five decades.

Unless banks start opening their coffers and lending money again, specifically in the form of mortgages, Sanders said no amount of Fed stimulus will help spur an economic recovery.

What’s more, any housing recovery that’s gaining steam through the end of 2012 is bound to be derailed by the looming fiscal cliff, Sanders warned. 

If Congress fails to reach a compromise on spending and the Bush-era tax cuts are allowed to expire, taxes will rise for millions of Americans. If that happens demand for homes is certain to plummet again. “The housing market is partially self-correcting because housing prices are going up. But when the fiscal cliff hits, let’s see how much legs the housing recovery has,” Sanders said

Sanders described the government’s housing policy as “schizophrenic” because on the one hand the Fed is trying to pump up demand by lowering mortgage rates while at the same time the Obama administration has said it will raise taxes by allowing the Bush tax cuts to expire for those making $250,000 or more. (Republicans want to extend or make the cuts permanent for all incomes.)

“They’re pulling in opposite directions. They can’t have it both ways,” he said.

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