- The Washington Times - Wednesday, March 12, 2008

The Federal Reserve moved dramatically yesterday to prevent surging interest rates on prime mortgages from short-circuiting the economy during the critical spring home selling season, sparking the best day on Wall Street in five years.

Interest rates on 30-year fixed-rate mortgages already have jumped from near 5 percent in January to 6.32 percent yesterday, and were threatening to go higher after last week’s panic selling in the market for top-quality mortgage securities backed by Fannie Mae and Freddie Mac.

The Fed calmed markets yesterday by offering to temporarily take those top-rated mortgages from banks and securities firms in exchange for more liquid Treasury securities. The move in conjunction with European and Canadian central banks sparked a surge of optimism on Wall Street, sending mortgage rates lower and spurring a 416-point jump in the Dow Jones Industrial Average — its biggest point gain since 2002.

By allowing Wall Street investment houses as well as banks to participate in the $200 billion funding bonanza for the first time, the Fed’s move also appeared aimed at averting a disastrous failure of major financial institutions such as Fannie Mae or Bear Stearns, a Wall Street powerhouse, both of whose heavy investments in mortgages have raised rumors of looming insolvency.

Danny Charles, analyst with RBS Greenwich Capital, said the recent turmoil in the prime mortgage market was a “cry for help” that the Fed heeded with yesterday’s actions. “If the goal here is to stem forced liquidations of mortgage paper [that were driving up mortgage rates], then this should help for the time being,” he said.

Fed Chairman Ben S. Bernanke expressed concern in testimony earlier this month that turmoil in the mortgage market had largely reversed the benefit of 1.25 points in rate cuts the Fed provided in January and early February. The Fed’s actions yesterday were aimed at alleviating the rise in mortgage rates by providing more liquidity for the market.

“The move has had a powerful psychological impact, and [mortgage investors and home buyers] can only hope that is sustained,” Mr. Charles said, but he expects the measures will provide only temporary relief to the deeply troubled market because it leaves banks and securities firms still encumbered with huge portfolios of money-losing mortgage investments.

The Fed for the first time said it would accept as collateral not only Fannie Mae and Freddie Mac securities, but any private mortgage security that is rated AAA by Wall Street credit agencies — a category that could include some subprime securities.

Mr. Charles said he thinks the Fed will draw the line against the most toxic mortgages and accept only securities that are not candidates for downgrades in temporary swap arrangements lasting up to 28 days.

“Clearly, the Fed does not want to own any of this stuff” or appear to be in the position of “bailing out” financial institutions that made poor investments, he said.

Analysts noted that the Fed’s action came too late to prevent another round of market-rattling first-quarter earnings announcements revealing big losses at banks and securities firms. Earlier announcements have rocked the markets and precipitated the stock market’s plunge into bear market territory this year.

“The Fed’s actions have met with some short-term success, but have only served to slow the decline [in credit markets], not stop it,” said Lee A. Olver, senior vice president of SMH Capital. He noted that the big jump in mortgage rates since January already has cut refinancings in half and snuffed out purchasing activity.

Whether the Fed’s action came in time to avert another rout in the housing market this spring will become apparent soon. Spring is traditionally the strongest selling season for homes and sets the tone for the entire year.

“It may be a big step in providing a temporary home for unloved mortgage product while confidence recovers,” Mr. Olver said, but “recovery in the housing and mortgage markets remains the key to economic recovery,” and that remains elusive.

The Fed has grown increasingly frustrated as none of the big rate cuts or other extraordinary measures it has taken since August seem to have made a dent in the housing or credit crisis. The Fed had been auctioning off funds to banks on a regular basis as well as accepting mortgage loans as collateral for bank loans for several months before yesterday’s actions.

“The Fed needed to do something else, because the rate declines and expectations of future rate declines really weren’t having any positive impact at all,” James Paulsen, chief investment strategist at Wells Capital Management, told Bloomberg Television. “You have to applaud them for coming up creatively with a way that gets more at the center of this crisis.”

Dwight Cass, analyst with Breakingviews.com, said the Fed’s willingness to wade deeper and deeper into the mortgage market turmoil is leading some on Wall Street to think it ultimately will step in and bail out failing institutions rather than risk damage to the economy. Even under the terms of yesterday’s temporary assistance, the Fed may end up holding banks’ unwanted mortgage portfolios much longer than it expects, he said.

“There’s a lot of talk about mortgage bailouts floating around,” he said. The Fed “needs to manage expectations so it isn’t seen as Wall Street’s lender of first, rather than last, resort.”

LOAD COMMENTS ()

 

Click to Read More

Click to Hide