by Keith T. Gumbinger
March 2008 -- Over the past nine weeks, we've seen three sizable cuts in the Federal Funds target rate -- one on an emergency basis and two expected -- bringing down that rate by 225 basis points (2.25%). We've seen like changes (plus an additional quarter) in the Discount Rate, the rate the Fed charges for funds it lends directly to banks.
Those are simply changes to the 'wholesale' cost of money.
To make more funds available at those lower rates, the Fed expanded the Term Auction Facility (TAF) to make up to $100 billion in new funds available to banks anonymously each month. This program has been well accepted (and fully utilized) by the nation's banks.
Having addressed bank needs, the Fed turned to finding new ways to pour lubrication on the smoking gears of financial service firms by introducing the Term Securities Lending Facility -- a way for such firms to swap illiquid mortgage securities for highly-liquid Treasury securities, thus enhancing their ability to raise cash. Since that process requires multiple transactions to clear before the desperate firm can get that cash, the Fed also announced a more immediate means of getting funds into their hands by lending them money directly at virtually the same terms and conditions as they will lend to highly-regulated banks.
These moves should help to keep firms from collapsing when struck with demands from investors to return funds (redemptions and margin calls) -- funds which they cannot hope to raise by selling most or even all of their holdings into a marketplace which just doesn't want them. The TSLF came too late to rescue Bear Stearns, but may save other firms that find themselves in the same boat.
There was also a need to jump-start the now-moribund market in which mortgages are bought and sold. To this end, regulators announced an expansion of the ability of the GSEs (a.k.a. Fannie Mae's and Freddie Mac) to purchase jumbo-sized mortgage loans in up to 71 metropolitan markets. (We'll be posting some user-friendly explanations of how this scheme will work, and how it can help you.)
All of these influxes of cash into the markets need to go somewhere. In normal times, investors would be buying up mortgage (and other paper) as a regular course of business. However, with distrust of any mortgage assets still pervasive in the market, not many buyers are willing to stick their necks out. In order to get more money at lower costs out to the street (that is, to mortgage and other borrowers) where it will do the most good, somebody has to buy up that paper. But as long as mortgages remain a disfavored investment, investors can't be counted on to help anytime soon.
This led to regulators lifting limits on the GSEs' portfolios, clearing the way for them to begin to buy up mortgages from the marketplaces and hold onto them if no downstream investors can be found to purchase the paper. This was enhanced by reducing the amount of capital that Fannie and Freddie are required to hold against those expanding portfolios, potentially freeing up billions of new dollars which can be put to work buying up still more mortgage loans. Taken together, these moves should help to drive down at least conforming interest rates in the market -- and there appear to be some early signs that this is the case.
This makes the expansion of Fannie and Freddie's books a key element in reviving the moribund housing and mortgage markets. Importantly, even if no downstream investors for mortgages can be found, Fannie and Freddie can buy and hold that paper until investors are willing to emerge from their shells and start buying again.
In addition to Fannie and Freddie being able to expand their holdings, the ability of the 12 Federal Home Loan Banks to accumulate mortgage-backed securities (MBS) for their portfolios was also enhanced. Collectively, the regional banks will be allowed to add an additional $100 billion of GSE-issued MBS to their books, adding another potential buyer of securities into a market desperately seeking buyers. Purchases by the FHLBs are of course voluntary, but that they are allowed to participate to a greater degree in these markets means that there may be some additional demand for such securities.
The FHA loan guarantee program was also expanded, and more marginal borrowers in high-cost areas may now have access to low-downpayment funds at attractive rates, too.
Of course, market changes coming as thick and fast as these (with any number of others on the way) means that it's not exactly clear what form mortgage markets will take, or how differently they may function from those in the past. However, it does mean that at least some vehicles are in place at critical financial choke points in the economy, even if the ultimate conclusion (or even full benefit) is unclear. At present, it's hard to know whether any or all of these changes will be subject to the laws of unintended consequences -- the Fed being left on the hook for bad mortgage paper, for example.
None of that seems to be of particular concern at the moment, nor the potential effects of lower interest rates on the dollar or inflation pressures. Stabilization of financial markets, mortgages among them, remains the goal. Proposals for re-inflating sagging home prices may be the next area which receives attention, but if the above measures work as hoped, the market may stabilize and reflate on its own as the combination of lower home prices and lower interest rates serve to improve affordabilty to levels not seen in a number of years.
As always, we welcome your feedback, too.
