mortgage

Federal Reserve tries a tame 'Twist'

Updated

4 p.m.

The Federal Reserve's latest move to help jump-start the economy has a twist: It won't do much to help consumers, borrowers or the housing market.

The Fed will go on a bond-buying spree -- again -- in an attempt to drive long-term interest rates lower than they already are. The much-anticipated plan, dubbed Operation Twist by observers, should help push rates lower, boost the housing market, make it easier for consumers and business owners to borrow and help create jobs. That's the Fed's theory and intention.

But analysts say Operation Twist barely makes a dent in the problem.

"I fear it won't have that much of an effect," says Nigel Gault, chief U.S. economist at IHS Global Insight. "There is plenty of liquidity out there already, and interest rates are already extremely low. ... Rates have not been an obstacle to growth."

After a two-day meeting, the Federal Open Market Committee announced it will sell short-term Treasury bonds and reinvest about $400 billion in long-term Treasury bonds by the end of June 2012. It will sell Treasuries maturing in three years or less to buy Treasuries maturing in six to 30 years.

"This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative," the Fed says in its statement. "The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate."

Operation Twist differs from QE1 and QE2, the two quantitative easing programs the Fed previously implemented, because it will not require the Fed to print new money to fund the bond purchases. With Operation Twist, the Fed will simply shift its investments around rather than increase the balance of its portfolio.

Will lower rates save the economy?

Mortgage rates have been at their lowest levels in six decades, but millions of homeowners can't refinance at the lower rates because they don't have enough equity in their homes. Many potential buyers, who would like to take advantage of the low rates, don't qualify for loans or are afraid to commit to a mortgage in a shaky economy.

The Fed said it will try to keep mortgage rates low by reinvesting in mortgage-backed securities as mortgages are paid off and as Fannie Mae and Freddie Mac repay debts they owe to the Fed.

"It's going to have a very marginal impact" Gault says. "It will keep mortgage rates steady. It might even reduce them a little bit but not much."

Even if lower rates were the answer to dragging the economy out of the hole, Operation Twist still wouldn't be enough to get the job done because its impact on long-term rates will be limited, analysts say.

"It would perhaps lower the 10-year rate by around 10 basis points," says Dean Baker, co-director of the Center for Economic and Policy Research in Washington, D.C. "This will be passed on in mortgage rates and other longer-term loans. A 10 basis point reduction in rates would have a very limited effect -- maybe boosting GDP by 0.1 or 0.2 percentage points at most."

Given the severity of the current crisis and the high unemployment rate, the United States needs the gross domestic product to grow at about a 5 percent to 6 percent pace, Baker says."But that does not seem to be in the cards," he says.

Gault says he doesn't expect long-term rates to fall more than 10 to 20 basis points. Others think rates may remain stable despite the Fed's newly announced policy.

"Mortgage rates should remain stable and close to current levels," says Brett Sinnott, director of secondary marketing at CMG in San Ramon, Calif. "Most of the market has this built in, so the reaction should be fairly subtle, and I would not expect it to last more than a day or two before we are onto the next piece of news."

So why did the Fed go with Operation Twist?

With so much doubt surrounding the effectiveness of Operation Twist, you may wonder why the Fed chose this maneuver. Simply put, it's because the Fed had to intervene to show investors that it has not lost control of the nation's economic situation.

"I think it's really a question of -- they want to help, they would like to stimulate growth, but they have limited options with limited effects," Gault says. "So rather than sitting there and saying 'we've done everything we can,' they are trying to move us a little bit in the right direction."

And among the few tools the Fed had in the shed, Operation Twist was the least controversial one.

Operation Twist met the least resistance among Fed members mostly because it differs from QE1 and QE2, the two quantitative easing programs the Fed previously implemented. Operation Twist will not require the Fed to print new money to fund the bond purchases. With Operation Twist, the Fed will simply shift its investments around, rather than increase the balance of its portfolio.

The Fed has more than doubled the size of its Treasury bond portfolio to about $1.65 trillion since the financial crisis started three years ago, and the Fed embarked on a bond-buying frenzy.

Any attempts to make that portfolio larger would encounter strong resistance by some Fed members and heavy criticism by market observers who say the latest round of quantitative easing, QE2, hurt more than helped the economy because it sparked inflation.

Operation Twist: better than nothing

With more than 14 million people out of work, the unemployment rate stuck at 9.1 percent and no signs of improvement in the labor market, the Fed felt the pressure to act. Rumor that Operation Twist would be announced after the FOMC meeting created huge expectations among investors. If the Fed didn't announce Operation Twist or a plan that didn't meet the market's expectations, the economy would take another hit, industry observers say.

"The stock market would take it very badly," Gault says.

Mortgage rates would likely have taken a hit as well.

"I think long-term rates, including mortgage rates, are at near-record lows today at least partially because investors have already moved in anticipation of the Fed announcing an Operation Twist," says Michael Fratantoni, vice president of research at the Mortgage Bankers Association. If the Fed had not adopted Operation Twist, long-term rates could have increased, he says.

Updated

2:15 p.m.

The Federal Reserve danced to the investors' tune and announced Operation Twist.

The Fed will again go on a bond-buying spree in an attempt to drive long-term interest rates lower than they already are. The theory is the lower rates will help boost the housing market, make it easier for consumers and business owners to borrow and help to create jobs.

But in practice, Operation Twist, named after a similar Fed program in 1960, may not have much of an impact on the economy, analysts say.

After a two-day meeting, the Federal Open Market Committee announced it will sell short-term Treasury bonds and reinvest about $400 billion in long-term Treasury bonds by the end of June 2012.

"This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative," the Fed says in its statement. "The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate."

Operation Twist differs from QE1 and QE2, the two quantitative easing programs the Fed previously implemented, because it will not require the Fed to print new money to fund the bond purchases. With Operation Twist, the Fed will simply shift its investments around rather than increase the balance of its portfolio.

Also as expected, the committee kept the federal funds rate, which is the rate at which banks borrow from each other, between zero percent and 0.25 percent. The committee announced in its last meeting that it would keep that key interest rate at near zero until 2013.

The federal funds rate, also known as overnight rate, is important to consumers because it influences the prime rate, which is currently 3.25 percent, and other short-term rates. The prime rate, rates on home equity lines of credit and variable-rate credit cards will remain unchanged.

Longer-term interest rates, including mortgage rates, could potentially fall 10 to 20 basis points as a result of the Fed's announcement, some experts say.

Fed day coverage

Sept. 20-21, 2011

The sovereign debt crisis in Europe continues to rattle the globe, while at the same time the U.S. economy is beset by prolonged high unemployment, a tumultuous stock market and renewed recession fears.

In the center of it all the Federal Open Market Committee is meeting for two days this week -- Tuesday and Wednesday -- to determine the direction of monetary policy. The meeting was originally scheduled for one day only.

This particular FOMC meeting may turn out to be more fateful than most -- or it may not. The world is waiting for more stimulus action from the central bank, and the question for many people is not if; it's when.

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