Mortgage Rates Fall as U.S. Expands Rescue

--200 bil will be used via Term Asset-Backed Securities Loan Facility (TALF) to buy high grade securities backed by consumer loans, including auto, student loand, cards, SMB, --500 bil will be used to buy agency MBS, driving 30y mortgage rate to 5.8% --100 bill will be used to buy agency bonds U.S. officials pledged to pump another $800 billion into ailing credit markets, much of it directly from the Federal Reserve -- a move that makes the nation's central bank a lender to almost every corner of American life. The Fed, whose traditional lending role has been to make emergency loans to banks, plans to purchase in coming months up to $600 billion of debt issued or backed by Fannie Mae, Freddie Mac, Ginnie Mae and Federal Home Loan Banks, all mortgage-finance businesses with close ties to the government. Paulson Looking to Boost Lending 1:56 Treasury Secretary Hank Paulson announces plans to try and help banks loan money out to people faster. But critics say that "throwing money at the problem" is what spurred the crisis to begin with. Video courtesy of Fox News. (Nov. 25) In addition, with support from the U.S. Treasury, the Fed will provide up to $200 billion in financing to investors buying securities tied to student loans, car loans, credit-card debt and small-business loans. The intervention, the latest in a series of unprecedented government actions, immediately pushed down rates on 30-year mortgages by as much as one-half percentage point. Lower rates could help borrowers looking to refinance or buy homes, and potentially bolster ailing housing markets. The Dow Jones Industrial Average rose 36.08 points, or 0.43%, to 8479.47, posting its first three-day string of gains since August. The moves are no guarantee of an end to the financial crisis, or to the recession that has gathered force in recent weeks. Since September, the Fed and the Bush administration have repeatedly changed course as they've attempted to navigate the financial storm. The latest action came just a few days after Treasury Secretary Henry Paulson had unnerved investors by suggesting he might hold off on making new commitments from the $700 billion Troubled Asset Relief Program approved by Congress in October. The Fed's new $200 billion financing program for consumer loans is backed by $20 billion of Treasury funds. It was announced one day after a government rescue of Citigroup Inc. The government has already made more than $4 trillion of financial commitments, ranging from direct investments to debt guarantees, through a wide range of rescue programs hatched by the Fed, Treasury and Federal Deposit Insurance Corp. That number could grow if markets worsen. Other programs in the works, like a large fiscal-stimulus plan being worked out by president-elect Barack Obama, promise to push the government tab higher. Mr. Paulson said on Tuesday that market problems would have been much worse without the bailouts. He added that the latest moves were aimed at increasing the availability of lending to consumers and homebuyers. "Nothing is more important to getting through this housing correction than the availability of affordable mortgage finance," he said. He added that the market for securities backed by consumer debt "came to a halt" last month, making it nearly impossible for millions of Americans to find affordable financing for everything from college to computers. These markets have deteriorated sharply. Yields on mortgage debt have increased, raising borrowing costs to many households. Last week, debt issued by Fannie Mae was yielding around 1.8 percentage points more than Treasury bonds of the same maturity. That compared to a 0.7 percentage point "spread" over Treasury bonds in September. Investors, including foreign central banks, have shunned Fannie and Freddie debt because of uncertainty about the government's backing, and because new forms of debt, such as bank borrowing backed by the Federal Deposit Insurance Corp., have gotten explicit government guarantees. As Fannie Mae and Freddie Mac's borrowing costs have risen, so have mortgage rates. The Fed's traditional main mission is to set short-term interest rates. Its target interest rate, now 1%, is already low, and some officials are leaning toward reducing it again in December. The Fed also lends to banks in need of short-term funding. The new programs transform the Fed into a mammoth lender with much broader scope. Over the past few months, the Fed has expanded lending programs to brokers and to businesses. It has even announced plans to start buying some of the complex debt at the heart of the financial crisis -- instruments known as collateralized debt obligations -- through its rescue of American International Group Inc., the troubled insurance giant. As its lending has expanded, the Fed's own balance sheet has also ballooned, from less than $900 billion in August to more than $2 trillion. With the new programs, it is likely to grow even more. While the Treasury has to borrow money from the public to finance its rescue programs, the Fed doesn't. A central bank can effectively create new money by pumping funds, also known as reserves, into the banking system. The Fed is doing that now. Its approach is similar to steps taken in Japan in the 1990s and earlier this decade, when the Bank of Japan pumped reserves into Japanese banks. The Fed is taking that process a step further. Not only is it pumping in reserves, it is deciding where that cash should go, through its own lending programs. "The Fed is going market to market and saying, 'Where is credit clogged?' and trying to deal with that in a direct way," says Laurence Meyer, a former Fed governor and now vice chairman of Macroeconomic Advisers, an economic consulting firm. There are many risks to this approach. Markets could become dependent on Fed financing, possibly slowing their own recovery. Fed officials are concerned about how they will exit from lending programs, but see that as a problem they'll have to confront when the crisis subsides, something that is still seen as far off. The Fed's approach, coupled with the fiscal stimulus planned by the incoming Obama administration, is also inflationary. But given a weakening economy, with unemployment rising and consumer spending slowing, Fed officials don't see inflation as a near-term risk. There are other risks: that the new programs won't work, that more money will be needed, and that the Fed could suffer losses on all of this lending, particularly with the economy so fragile. The central bank is taking several steps to avoid this. The Treasury has agreed to absorb the first $20 billion of losses on the new $200 billion lending program for car loans, student loans, and other consumer credit. The structure of the program is complex. The central bank will lend money to investors via big banks known as primary dealers. Investors can use the money to buy AAA-rated securities tied to consumer debt. The Fed's goal is to bolster those markets, sparking more lending to consumers and lower interest rates for students, car buyers and others. But if consumer-loan delinquencies rise sharply and these securities default, losses will ultimately fall to the Fed and Treasury. The program could grow beyond $200 billion, and be expanded to include other asset classes such as commercial real estate. The mortgage program is more straightforward. Beginning next week, the Fed will start buying $100 billion of debt issued by Fannie Mae, Freddie Mac, and the other government-sponsored enterprises. It also plans to buy up to $500 billion of mortgage-backed securities that these firms guarantee. Private asset managers will be hired to manage this portfolio of investments. By purchasing securities tied to mortgage debt, the Fed hopes to push up the price of the debt, thereby lowering yields. This maneuver, theoretically, should push down mortgage rates. "We expect this action will measurably improve conditions in the mortgage markets and will have beneficial effects on housing and the broader economy," said Michael Feroli, an economist at J.P. Morgan Chase & Co., in a note to clients Tuesday. More Fed Aid Sets Off a Rush to RefinanceDiscuss: Will the Fed's latest programs be effective in easing the consumer credit crunch? FDIC Says Number of Problem Banks GrowsFed statements on TALF, GSEsEcon Newsletter: Click here to sign upWith Tuesday's announcement, the Treasury has effectively committed $330 billion of the $700 billion rescue package. It needs to go to Congress to use any funds beyond the initial $350 billion authorization. Taking such a step could be politically difficult. The law passed by Congress in October requires the administration to submit a report detailing how it plans to use the second $350 billion when it makes such a request. That would make an easy target for lawmakers critical of Treasury's frequent pivots on how it intends use the TARP program. Once a request is submitted, Treasury would then have to wait up to 15 days while lawmakers decide whether to vote to withhold the funds. Without a vote, the funds would be released. There is growing sentiment that lawmakers should attach new restrictions on the second chunk of funds to reduce Mr. Paulson's leeway in implementing the program. Some Democrats and Republicans have pressed for Treasury to do more to avert foreclosures, as required in the legislation authorizing the financial rescue plan. Separately, Treasury disclosed on Tuesday the criteria it is using when determining whether to bail out financial firms. Among the factors Treasury said it considers: the effect on creditors and counterparties if an institution is allowed to fail; whether the failure of the institution would lead to follow-on failures at similar institutions; and whether there's a high probability the failure of the firm would cause "major disruptions to credit markets." Treasury said it would evaluate firms individually to determine whether they are "systemically significant." It said there are few, if any, limitations on the types of investments it can make if a key financial institution is failing. http://online.wsj.com/article/SB122761978389056335.html?mod=todays_us_page_one