Federal Reserve keeps rates near zero

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The Federal Reserve has taken the last major tool out of its box: buying Treasury notes to knock down long-term interest rates.

Fed stands pat


The federal funds rate stays at historic low.

The Fed’s rate-setting Federal Open Market Committee did the inevitable today and kept its target for the federal funds rate unchanged, at a range of zero percent to 0.25 percent. As a result, the prime rate remains 3.25 percent. That means interest rates will stay unchanged for consumer debt that is pegged to the prime rate, including home equity lines of credit and some credit cards.

No more federal funds rate cuts are possible, but the central bank still has methods to stimulate borrowing. One way is for the Fed to buy long-term Treasury securities. For the last three months, the Fed has said it would consider buying Treasuries; now it says will indeed try that approach. It will buy up to $300 billion in long-term Treasuries over the next six months, with the goal of decreasing interest rates on loans to businesses and consumers.

Fed moves drive down mortgage rates

On top of that, the Fed will more than double its purchases of mortgage-backed securities. That should put a ceiling on the 30-year fixed mortgage rate, which has been below 6 percent all year and could conceivably park itself below 5.5 percent for months.

Last year, the Fed announced that it would buy up to $500 billion in mortgage-backed securites; in reaction, mortgage rates dropped a full percentage point in six weeks. Today, the Fed pushed another $750 billion in mortgage-buying chips onto the table. Now the central bank is committed to buying up to $1.25 trillion in mortgage-backed securities this year.

Federal Reserve’s buying spree
  • Action: Buy up to $300 billion in long-term Treasuries.
    Goal: Cut interest rates on loans for businesses and consumers.
  • Action: Buy $750 billion more mortgage backed securities.
    Goal: Further reduce mortgage rates.
  • Action: Buy up to $200 billion of debt from Fannie Mae and Freddie Mac.
    Goal: Indirectly lower mortgage rates.

That’s not all. The Fed doubled its commitment to buy debt from Fannie Mae and Freddie Mac, up to $200 billion. This will have an indirect effect of lowering mortgage rates. It seems clear that fixing the mortgage market is among the Fed’s top priorities.

“Bold” is the best word to describe these steps. The Fed is not messing around.

“I think this is just what we needed,” says Dick Lepre, senior loan consultant with Residential Pacific Mortgage in San Francisco. “We’ll see much lower rates tomorrow.”

Lepre scoffs profanely at the attention paid to the bonus scandal at AIG. It’s a sideshow, he says. “This is what’s important; what the Fed is doing here,” he says.

Jim Sahnger, mortgage consultant for Palm Beach Financial Network in Stuart, Fla., worries that potential borrowers will watch rates fall in the latter part of this week, and then wait for rates to fall to the much-anticipated 4.5 percent range. “Can we get them at 4.5? No,” he says, and he worries that potential borrowers will get burned by waiting for rates to fall that low.

Even if rates plunge, a tsunami of mortgage applications could swamp the system, just as it did in January, Sahnger says. And lenders will repeat what they did back then: raise rates to discourage applications so staff can process the applications they already had.