From CNBC to The New York Times to USA Today, there is great talk about what The Fed may or may not do on September 21st. While the Fed will not come out with QE3, there are talks of something very similar. Enter Operation Twist. So what is Operation Twist?

So if we leave politics aside and look at this on plain economic theory Operation Twist is flattening the yield curve. Basically what the Fed will do is sell Short Term paper and buy long term paper. By selling short term paper the hope is to keep short term rates stable (slight increase perhaps). The buying of long term paper is meant to only affect long term rates. The thought is that it would decrease lower term rates. The basic idea behind all of this is to lower long term rates without increasing the amount of money in the system (goal is not to increase the risk of inflation). We are simply shifting, or “twisting” the focus. The name Twist however, comes from the song Twist which was wildly popular when this was same theory was put to use for the first time in 1961.

Why would the fed want to lower long term rates? Long term rates are tied to many things, but most notably business expansion and interest rates for mortgages. Again, the HOPE is that lower longer term rates will spur business expansion, increase hiring, and spur housing purchases.

I will ignore other areas of the economy where this could affect (commodities market, forex, etc) as well as ignore the fact that this was attempted during the Kennedy Administration during 1961 with little results. What does it do to housing?

Well, if it lowers interest rates, it will allow people to refinance again to even lower rates and it should entice some people to purchase. Many who are now dealing with rent increases as the rental market gets hotter than ever may see buying much more attractive than before. However, right now rates are pretty damn low. Two of my recent clients locked in at 4.35% on a conventional 30yr fixed…not bad at all. So what will get people to buy? Under 4%? 3.75? Well, lets look at a scenario. Lets pretend you’re going to buy a house that is $250,000. You are putting 10% down so your mortgage is $225,000. How much would moving from 4.35% to 3.75% really save you? (We will ignore PMI, Property Taxes and Insurance. We will just look strictly at mortgage payment only. Also keep in mind these are PERFECT SCENARIO numbers. Operation Twist affected rates by only 15 to 20 basis points in 1961).

$225,000 – Loan Amount

Payment @ 4.35% = $1,120.08

Payment @ 3.75% = $1042.01

Savings Monthly: $78.07

Savings Yearly: $936.84

Would the above make a difference to you? Will it make a difference to the average person renting? I don’t know. I think it would definitely affect property investors. It may push them to remove some cash from the sidelines and get it out into the market once again. This might be enough to push them. It also may be enough to push some home buyers off the fence onto the buyer side. But will it truly spur home buying to SUSTAINABLE levels? It is really hard to say. We saw that the first time home buyers tax credit pushed people off the fence but didn’t create sustainable demand. It was a stimulus but it was a quick hit of caffeine and nothing more. All it did was shift demand forcing people to buy sooner rather than later. We quickly realized that and the markets freaked out when they saw home sales “decrease” a few months later. Then they really freaked out when they saw year over year sales in decline in certain markets.

“Operation Twist” (if effective in lowering rates) will definitely spur some home buying but more than likely just forcing people to buy this month instead of next month when rates may increase. It will also definitely spur home refinancing as well which will keep mortgage brokers very busy. But I’m not sure if it will do much of anything else. Keep in mind this is taking into account this is actually effective in decreasing something such as mortgage rates by over 0.5% APR.