This is a good read. It helps to understand why interest rates dipped so low last week & and what the fed is doing to keep them down. Might want to grab a cup of java first. :)
RISMEDIA, March 20, 2009-(MCT)-The Federal Reserve escalated its war on the nation’s credit crisis, announcing that it would more than double the amount of money it will spend in the coming year in an aggressive effort to force down interest rates on mortgages - perhaps by as much as one percentage point - as well as other business and consumer loans. The move, which cheered the markets, is designed to keep money flowing through the economy’s clogged credit arteries to foster economic recovery.
“They are trying to fire absolutely every weapon they can,” said Nigel Gault, chief U.S. economist at IHS-Global Insight, a Lexington, Mass.-based forecasting firm. “It improves the odds that we’ll bottom out in the second half of the year.”
David M. Jones, a former Fed economist and president of DMJ Advisors, a Denver-based consulting firm, said he expects the Fed actions to help lower conventional mortgage rates from their current level of just below 5%, perhaps to near 4%.
“I’ve never known when the Fed has taken a move this powerful in easing monetary policy,” Jones said. “If you bring the interest rate down that much, we’ll have a huge amount of refinancings and that will create money for banks” and help shore up the financial sector.
The news had an immediate impact on Wall Street, where the stock market reversed course and posted a modest rally, and yields on 10-year Treasuries dropped by 0.5 percentage points, to 2.5%. Many interest rates, including mortgage rates, are pegged to the 10-year note.
“Bottom line, these actions by the Fed certainly increase the chances of a housing bottom sometime this year, and a return to economic growth by year end,” said Scott A. Anderson, chief economist at Wells Fargo Economics in Minneapolis. “Ten-year Treasury yields plunged by half a percentage point shortly after the statement, which will drive significantly lower mortgage and corporate bond rates across the country. I sense a refinancing or financing opportunity coming on.”
Guy Cecala, editor of trade publication Inside Mortgage Finance, said that many consumers may find that the rates their banks actually offer are higher than they might expect. And that may not change quickly, especially since lenders are already swamped with applications for loan refinancings and modifications. “If they have all the business they can handle, what’s their incentive to lower their rates?” Cecala said. “That has been the challenge the government has faced from day one. You can’t force lenders to offer the cheapest possible rates.”
Although the Fed has kept the rates it charges banks near zero since December, interest rates for consumers and businesses have remained significantly higher because banks continue to be cautious about issuing new loans as the economy declines and unemployment rises.
Gault said that before the credit crisis, the difference between the 10-year Treasury note and rates offered to consumers for conventional loans was about 1.5 percentage points. It’s now around 2 percentage points and, he said, “I don’t expect the spread to go back down to 1.5.”
With its interest rates already hovering just above zero, the Fed has turned to other programs to generate money, or liquidity, in the credit system, which is the lifeblood of the economy.
The Fed’s announcement significantly expands these programs and adds a new one to the pack as well: the direct purchase of $300 billion in long-term U.S. Treasury bonds.
The central bank’s purchases will increase demand for the bonds, which will permit the government to decrease the yield it has to pay to attract buyers. Many loan rates are pegged to the yield on Treasury securities.
“The Fed is now trying to influence not just the spread between private interest rates and Treasuries through its mortgage-backed securities purchases, for example, but to pull down the entire spectrum of interest rates by driving down the rate on benchmark Treasuries,” Gault said.
In addition, the Fed will increase to $1.25 trillion the amount it intends to spend to buy mortgage-backed securities issued by government agencies including Fannie Mae and Freddie Mac, and will double its purchases of agency-backed bonds from $100 billion to $200 billion. These moves should increase the ability of the government-backed mortgage giants to continue to provide financing to the housing market.
Fed governors, who voted 10-0 in favor of the moves, described them as necessary to try to revive an economy in serious distress.
“Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending,” the Fed’s rate-setting committee said in a statement. “Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. U.S. exports have slumped as a number of major trading partners have also fallen into recession.”
The committee said it would keep its benchmark rate for banks at the current level of 0% to 0.25%, saying they anticipate “that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.” Governors said the Obama administration’s upcoming program to help banks shed bad assets and strengthen their balance sheets will work in concert with the central bank’s actions.
“Although the near-term economic outlook is weak, the committee anticipates that policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth,” the policymakers said.
It remains to be seen how lenders will respond to the Fed’s actions. Many lenders have been unable to significantly expand their lending, in part because of a reduced ability to sell their loans on secondary markets, and in part because many of them reduced staff in their loan origination departments.
Moreover, many borrowers are higher risks for banks now than they would have been a short while ago. Some have lost significant equity in their houses. Others have lost jobs or may be on shakier financial footing.
“We’re not in a credit crunch because of an inability to provide credit, it’s because of an unwillingness to create credit,” said Joel Naroff, president of Naroff Economic Advisors in Holland, Pa. “The private sector is not doing it because the larger banks can’t do it. They can’t take the risks.
“The Fed is being the visible hand of the economy because the invisible hand of the economy has failed,” Naroff added.
© 2009, Tribune Co.
Distributed by McClatchy-Tribune Information Services.
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