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Keep an eye on today's Fed statement

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January 28, 2009 – Comments (2) | RELATED TICKERS: FED

The Federal Reserve concludes its two-day meeting today and it will issue a statement at around 2:15 PM.  I'm sure that some of you are saying "Rates are already as close to zero as they can go and we know that they aren't going to raise rates, so who cares?"  Here's why the statement could be important.

There is a very good chance that the Fed will begin to make massive purchases of long term Treasuries in an effort to push interest rates lower and it might give the market a clue about whether it will pursue this course of action in its statement.  Mortgage rates usually move in tandem with the rates on long term Treasuries.  Even though the Federal Funds rate is currently near zero, the average rate for 30-year fixed mortgages is still sitting at well over 5%.  The gap between the rates on 30-year mortgages and 10-year Treasuries has not been this great during a period of Fed loosening since 1982. The yield spread between the two is currently 2.5%, compared with an average of 1.7% over the past twenty years.

The thinking behind the Fed buying Treasuries is that the government needs to find a way for to get mortgage rates lower and do it quickly to put a floor under housing prices and help stimulate the economy.  Getting mortgage rates to drop into the 4s would do much more to put money into people pockets than a stupid piddly one-time $500 payroll tax break from the government would do or those dumb stimulus checks that they sent out last year did. 

If one thinks about it, lower rates would likely be the single most effective and quickest way for the government to fix two major problems with the economy...falling home prices and slowing consumer spending.  Banks are going to continue to hurt and need Federal assistance anyhow until the value of the garbage that they have on their books stops falling.  If the government is going to keep pumping money into banks to keep them from failing anyhow, why not try to prop up the asset prices that have proven so problematic for them?  Doing so would likely help average citizens and banks at the same time. 

This situation is a little tricky because by making a nice spread on mortgages, banks that are desperately in need of cash are making money, but putting a floor under falling home prices would actually probably be better for banks than having them make a few bucks more on the mortgages that they issue.  One of the main reasons that banks keep going back to the government with their hand out is because the value of the assets on their books keeps falling.  The imploding housing market is one of the major drivers of this asset value deterioration.

As one can clearly see by looking at the latest Case-Shiller numbers above.  Housing prices aren't even close to finding a bottom.  Prices are falling at an alarming rate.  The sooner a floor can be put in the housing market, the sooner banks will stabilize.

I generally am against massive government intervention in anything.  I prefer the government to spend less, not more and to interfere less with the free markets, not more.  Furthermore, I realize that a 5% mortgage is already a historically low rate.  My being in the same camp as the National Association of Realtors chief economies Lawrence Yun, who also believes that 30-year mortgages should be in the 4% range, makes me sick. 

Having said this, the proponents of this strategy do have a point.  For example, if I was able to shave a point off of my mortgage rate by refinancing (I currently have a 30-year fixed at 5.75%), I would save several hundred dollars per month.  That's every single month for the next 30 years, not just a silly one time pop.  The government's already wasting tons of money on who knows what, at least this plan directly benefits me. 

Putting hundreds of dollars per month back in the pockets of homeowners who refinance and shaving hundreds of dollars per month off of the monthly cost to buy homes that are on the market would be a much better way to stimulate consumer spending than extending unemployment benefits for a couple of months or tossing people a token $500. 

Studies have shown that one-time tax breaks are more likely saved than spent.  They don't do nearly as much to stimulate economic activity as permanent tax cuts do.  It is unlikely that the new administration will be able to pass through any sort of tax cuts with the budget deficit soaring and Democrats like Pelosi screaming for the immediate repeal of the Bush tax cuts.  If they government won't cut taxes permanently, it can at least cut people's monthly expenses.  Lower mortgage rates would have almost the same effect as a tax cut.

Deej

2 Comments – Post Your Own

#1) On January 28, 2009 at 2:08 PM, angusthermopylae (39.59) wrote:

Hmm...with 10 minutes to go, I'm wondering:  If the Fed purchases Treasury notes, where does the money come from and where does it go?

As I understand your article, Threasury notes are basically debt--obligations for the govern-mint (hee-hee) to pay people/institutions over the life of the note.

If the Fed buys those notes at higher prices, pushing down the effective interest rate (and hopefully [to them] dropping mortgages prices), does that essentially "flood" the economy with dollars now, as opposed to feeding in those dollars over time?

 

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#2) On January 28, 2009 at 2:48 PM, TMFDeej (99.40) wrote:

Fed pledges to use all tools to help economy

"The Fed agreed -- with one dissent -- to keep the targeted range for the federal funds rate between zero and 0.25 percent. The funds rate is the interest banks charge each other on overnight loans."

What freaking idiotic hawk wants to raise interest rates right now?  How can they possibly be so out of touch with what is going on with the economy.  Good grief.

Related to the post above:

"Having taken the unprecedented step of slashing its key rate to record lows at its previous meeting in December, the central bank pledged anew to look to other unconventional ways to revive the economy.

Specifically, the Fed said it is now "prepared" to buy longer-term Treasury securities if the circumstances warrant such action."

Deej

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