- The Washington Times - Thursday, March 19, 2009

With mortgage rates already hovering at record lows, the Federal Reserve on Wednesday moved to force them still lower with a dramatic $1.2 trillion expansion of its debt-buying programs.

The central bank said it would start buying up to $300 billion in Treasury bonds as well as another $850 billion in mortgage bonds from Fannie Mae and Freddie Mac - a move sure to drive 30-year rates of less than 5 percent still lower.

Although the move was an elixir for the economy and markets, it risked stirring controversy because the central bank has essentially started printing money to help finance federal deficits exceeding $1 trillion this year and next.

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The Fed took action as the average rate on 30-year loans hit a record low of 4.89 percent, spawning a major refinancing wave that is helping consumers cope with their huge debt burdens, according to the Mortgage Bankers Association.

Mortgage applications are up 32 percent from a year ago, with most of that for refinancing rather than purchasing homes.

The Fed’s move is aimed at encouraging that trend as well as reversing a deep contraction in the U.S. economy that has spread to the rest of the world in a dangerous downward spiral that the central bank is trying to break.

The massive expansion of the Fed’s debt-buying program provoked an immediate drop in long-term rates. The rate on Treasury’s 10-year bond fell to 2.50 percent from nearly 3 percent earlier in the day, presaging what is likely to be a similar half-point drop in 30-year mortgage rates in coming days.

The Fed said it would buy another $750 billion in mortgage-backed securities from Fannie Mae and Freddie Mac, and another $100 billion of the agencies’ debt, bringing its mortgage debt purchases to a total of $1.45 trillion this year.

Going beyond the mortgage purchase program begun in December, the central bank announced it would for the first time purchase $300 billion of Treasury bonds in the next six months - a move that will help lower rates on all types of loans to businesses and consumers.

The Fed purchases also will help the Treasury finance a deficit that is expected to reach an unprecedented $1.75 trillion this fiscal year. When the Fed buys the Treasury’s bonds, it essentially prints money and funnels it into the Treasury bond market.

When the Treasury borrows the money from investors, by contrast, it must pay back the money with interest. The Treasury does not have the same power to print money that the Fed has.

The Fed also kept its target for short-term interest rates near zero to help bring the economy back from a deep recession. Mortgage brokers say the extremely low short-term rates already are helping people with adjustable-rate mortgages cope with mortgages that reset at market rates after three to five years.

“The Fed has today crossed a fine line,” said Harm Bandholz, an economist at Unicredit Markets. “The Fed sent the message to the market that it will indeed employ all available tools” to combat the recession and help consumers and the federal government cope with their huge debt burdens.

Although the Fed succeeded in immediately reducing interest rates, it got a warning signal from global foreign exchange markets, where the dollar fell more than 2 percent against the euro and other major currencies.

“This indicates the market´s concern about the monetization of public debt,” Mr. Bandholz said. The Treasury’s biggest creditor, China, already has voiced misgivings about the huge amount of debt the Treasury is issuing and whether the debt will hold its value in dollars.

The Fed noted that inflation is not a problem because of the weak economy. The inflation rate in the past year was a minuscule 0.2 percent, according to a Labor Department report released Wednesday.

Many economists say deflation is more of a threat now than inflation, because of the rapid collapse in the economy in recent months. Inflation was running close to 6 percent as recently as last summer, before the economy started imploding.

“At the moment, the Federal Reserve is focused on beating the recession and defeating the budding deflation psychology,” said Sung Won Sohn, an economics professor at California State University. “However, there are people in and outside of the central bank worrying about inflation in the future.”

Inflation could accelerate once the economy starts recovering because of all the money the Fed has printed to finance its unprecedented debt purchase programs.

“In the short run, the Fed easing is a plus,” said John Silvia, chief economist at Wachovia Securities. But it “may generate more problems down the road with a combination of higher inflation premiums and a weaker dollar to boot. Higher long-term interest rates are the likely outcome.”

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