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Nick Napoletano's Blog

By Nick Napoletano | Agent in Red Bank, NJ

Fed Has More Ammunition After Firing Rate-Cut Bullets.


While there are limits to how low short-term interest rates can go, the Fed has shown recently that there are few constraints on how large its own balance sheet can become. Since late August, the value of assets held by the Fed has grown to more than $2 trillion from a little less than $900 billion. The Fed has essentially created cash and used it to fund a multitude of new lending facilities, including a program to buy private commercial paper, one to rescue loans for American International Group and one that pumps dollars into financial institutions overseas through other central banks. This activity is sometimes called quantitative easing. Rather than focus on the cost of money in the financial system -- which is the interest rate -- policy makers focus on the quantity of money in the system. Now, the Fed and Treasury are considering a program in which they would team Fed loans with funds from the Treasury's $700 billion financial-rescue program to acquire securities from troubled financial institutions. In addition to targeting already-low short-term interest rates, the Fed could try to lower long-term ones, which could bring down costs on everything from 30-year mortgages to car loans to medium-term corporate bonds. "It is longer maturity rates that matter for economic activity," said Vincent Reinhart, another former Fed staffer who co-authored work on the subject with Mr. Bernanke. The Fed could achieve this by purchasing long-maturity debt, including Treasury bonds or debt issued by Fannie Mae and Freddie Mac. The Fed could seek to influence longer-term interest rates by committing to keep short-term rates low for a long time. That could force investors to price in lower rates for longer-term securities, too. The Fed took such a step in 2003 when it committed to keep the federal-funds rate low for a "considerable period."

Comments

By Nick Napoletano,  Wed Nov 26 2008, 09:13
It looks as though serious measures are finally being taken to help out the housing industry. I have been saying since January that the economy will not recover until housing stabilizes. I hope they are not too late. Last week Treasury Secretary Paulson and Fed Chairman Bernanke gave testimony in front of Congress and took some pretty serious heat. The rest of the week we saw the Fed buying up 10 year Treasuries in an attempt to bring down the rate on Treasuries to help drop the rate on mortgages.

This gave us the lowest 10 year Treasury rate I have ever seen hitting 3.01 %. Unfortunately it was not enough to entice buyers to start buying mortgage backed securities. This prompted the announcement by the Fed today that they are going to buy 600 billion worth of mortgage backed securities from FNMA, FHLMC and GNMA. This was the explicit grantee we needed to get mortgage rates to fall.

The Fed had seized control of the failing FNMA and FHLMC months ago but their backing of the mortgages was still an implied one. The purchase of these securities changes everything. Rates dropped about 3/4% today. That is a substantial one day drop. There is a good chance Rates will drop further in the coming days as this announcement sets in.

We are at 5.5% today on a 30 year fixed rate mortgage and this could go into the 4's considering the current 10 year Treasury at 4.10%. This will not only create refinance opportunities but also should bring buyers back into the market. Yes we are still lending money and still have some creative ways to get loans done contrary to what you read and hear in the news. It is not what it once was but that is probably a good thing.

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