Fed will buy $500 billion in securitized home loans |
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Second, Kennelly says, "this news also couldn't be better for current homeowners who want to stay in their homes but
can no longer afford the payments due to their adjustable-rate mortgage increasing. By interest rates coming down, combined with
lenders easing some of their qualification requirements, more and more homeowners in this situation will be able to refinance."
Dan Green, a mortgage broker for Mobium Mortgage in Cincinnati, calls the Fed's purchase plan "an explicit safety net
for lenders, and that should encourage more lending."
The Fed's decision to cut mortgage rates won't help people who can't refinance because they owe more than their houses
are worth. And people who already are two or three months' behind on their home loans probably won't get much out of it, either, says
Dean Baker, economist for the Center for Economic and Policy Research, a Washington think tank.
Lack of transparency
Baker worries about lack of accountability or transparency: The Fed and the Treasury have not disclosed details about their purchases
under the Troubled Asset Relief Program, setting a precedent for secrecy about the Fed's purchases of mortgage debt under the plan
announced Tuesday. "We don't know who they're going to be buying bonds from, or how much they'll pay -- or if they'll overpay," Baker
says, adding that if the Fed pays a dollar for a security that's worth 20 cents, "that's the same as handing (the seller) 80 cents."
Baker adds: "I think it takes a lot of gall to do something like this."
Green says that there is an element of moral hazard in the Fed's action: In the future, borrowers might expect a bailout
from the unintended consequences of this action. Nevertheless, the Fed's buying binge might be the best way out of a dilemma. "On moral
hazard, some say it led to the bubble. It may now lead the economy back," Green says, koan-like.
Yields fall, mortgage rates do too
By buying mortgage-backed securities, the Fed will be taking direct action to reduce mortgage rates. That's because mortgage-backed securities
behave like bonds. When bond prices rise, their yields fall. A wonkish detour into the behavior of bonds will illustrate this point.
A bond is an IOU. Let's say you lend someone $100 and the borrower gives you a piece of paper, promising to give you $105
a year from now. That paper is a $100 bond with a 5 percent yield. The yield is equivalent to an interest rate. Now assume that the
government stepped in and offered to give the borrower a better deal: $102 now in exchange for $105 a year from now. The bond's yield would
be roughly 3 percent. That's how the bond's yield gets lower as the price gets higher.
The Fed says it's going to be that buyer who pays a higher price for the bond, causing the yield to drop. As the yields
on mortgage-backed securities fall, consumers generally see mortgage rates fall, too.
By pledging to buy up to $500 billion in mortgage-backed securities over the next 12 to 18 months, the Fed is signaling that
it's ready to buy a big share of the conforming mortgages underwritten during that period. That could keep bond yields and mortgage rates
down. So far this year, Fannie and Freddie have issued about $857 billion in mortgage-backed securities, and the issuance pace has slowed
dramatically in recent months.
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