The last headline report of a multi-billion dollar loss on mortgage related securities was more than month ago. Interpret this as evidence that the financial markets are returning to normal for people and companies seeking construction financing. There will still be reports of mortgage related losses among lenders late to acknowledge their bad investments or whose initial write-off was not big enough. But the sum of these will no longer be large enough to abruptly boost rates or reduce availability for construction borrowers.

Nonetheless, commercial and jumbo mortgage rates will continue to have larger than normal spreads over prime conforming residential rates. That is because these investments are speculative; the borrower-owner has to find a tenant in an economy with subpar growth and no certainty yet when economic growth will return to the normal (3%) range. The current spreads should gradually diminish through the end of next year.

It is time for contractors and their suppliers to again worry about finding customers not building capital.

Long term rates inched slightly higher in April and through mid-May bringing all mortgage rates up slightly in spite of more reductions in short term rates by the Federal Reserve Board. The FRB appears to be done with rate cuts and is now turning its attention to carefully watching that it has not generated too much inflationary pressure.

So far inflation expectations have remained manageable, just over the FRB upper inflation target of 2%. Increasing the Consumer Price Index shows that inflation in oil and other commodities is spilling over into end product prices as well as services. But the spillover is quite small. Most of the added cost at the commodity level are being offset by improved productivity or reduced manufacturer and distributor margins. This is typical. But it is also typical that a ‘breaking point” is eventually reached when the offsets begin to ebb and a burst of inflation occurs throughout the Consumer Price Index.

This is the nightmare scenario that the FRB is now worrying about. This happened during the 1970’s and took a deep recession and much of a decade to reverse. The FRB sees its principal responsibility as fight inflation. It will not hesitate to raise interest rates next year if it perceives that inflation is bigger threat to the economy then unemployment.

U.S. Construction Finance Environment — May 2008

	Financial Market Benchmark Rates
	Previous				Annual Average
	Month				Actual		Forecast
	(Apr 08)	Latest			2006	2007	2008	2009
Federal Funds Rate (overnight)	2.28	May 07 08	1.94		4.96	5.02	2.33	2.73
1-Year Treasury Bill (T-Bill) Rate	1.74	May 09 08	1.94		4.93	4.52	2.04	2.66
10-Year Treasury Bill (T-Bill) Rate	3.68	May 09 08	3.85		4.79	4.63	3.79	4.48
Prime Bank Rate1	5.24	May 07 08	5.00		7.96	8.05	5.32	5.53
1 Base for home equity, contractor and business investment loans
	Mortgage Loan Rates
	Previous				Annual Average
	Month				Actual		Forecast
	(Apr 08)	Latest			2006	2007	2008	2009
1-Year Adjustable Rate Mortgage	5.19	May 08 08	5.29		5.53	5.56	5.03	5.13
5/1 Adjustable Rate Mortgage	5.58	May 08 08	5.67
15-Year Fixed Rate Mortgage	5.47	May 08 08	5.60
30-Year Fixed Rate Mortgage	5.92	May 08 08	6.05		6.41	6.34	5.70	5.61
	Previous					Highlights Short rates fell sharply in April in response to weak loan demand and aggressive monetary easing but long rate increased in line with rising inflation expectations.
	Month		Latest
Core Inflation Rate2	2.0% (Feb 08)		Mar 08	2.1%
Inflation Expectations3	2.33% (Apr 08)		May 1 08	2.38%
2Based on personal consumption expenditures (less food and energy), year over year. 3Based on rates for 10-Year inflation-protected Treasury securities.