Fed debt plan shaves nearly 1 point off mortgage rates

Bloomberg News

U.S. mortgage rates plunged by the most in at least seven years yesterday as a Federal Reserve pledge to buy $600 billion of debt succeeded where seven cuts in the central bank’s benchmark rate had failed.

The average rate for a 30-year fixed mortgage fell to about 5.5 percent last night after starting the day at 6.38 percent, according to an estimate from Bankrate Inc. It was the biggest one-day drop in at least seven years, said Holden Lewis, of the North Palm Beach, Florida, publishing and research firm. Today, the rate is "bouncing around" between 5.63 percent and 5.9 percent, he said.

Federal Reserve Chairman Ben Bernanke had received little help from lenders in his previous efforts to revive the U.S. housing market and halt its drag on the economy. The spread between the 10-year government bond yield and the average U.S. fixed mortgage rate was 2.8 percentage points last week, the widest since 1986, as banks hoarded cash rather than lower financing costs for homebuyers.

"Home resales have hung up because rates are high and because mortgage money has been scarce," said Neal Soss, chief economist at Credit Suisse Group in New York. The Fed’s move "may hasten the day when we finally find a bottom in housing."

The central bank pledged to purchase up to $500 billion in so-called agency debt as well as up to $100 billion in direct debt of Fannie Mae and Freddie Mac, the world’s two largest mortgage buyers, and Federal Home Loan Banks. The announcement was released at 8:15 a.m. New York time yesterday.

The Fed also said it would set up a $200 billion program to support consumer and small-business loans. Together, the programs almost match the $864 billion of U.S. currency in circulation, as reported by the central bank in a Nov. 20 statement.

"I was sitting in my underwear getting dressed in the morning when it came on TV, and I told my wife, ‘Rates are going down today,’" said Henry Savage, president of PMC Mortgage Corp. in Alexandria, Virginia. "Instead of buying stocks in stupid banks, the government finally is going to make a move to clear assets from the market."

Rates for a fixed rate mortgage with no fees or closing costs tumbled to as low as 5.25 percent from about 6.25 percent, Savage said.

"The market has been very good to me today," said Savage, who spoke last night from a bar where he was celebrating the rate drop with friends.

Homeowners who have enough equity to refinance their existing mortgages will get a boost as well, said Bob Walters, chief economist of Quicken Loans in Livonia, Michigan.

"You’re going to see an immediate impact on people who can refinance, taking their 6.5 percent interest rate to 5.5 percent or so," Walters said. "That will put $200 a month in their pockets."

Almost 20 percent of U.S. mortgage borrowers owed more on their loans than their house was worth in the third quarter as foreclosures depressed prices and the economy weakened, according to an Oct. 31 report by First American CoreLogic. Those owners would have a difficult time refinancing, Walters said.

The Fed’s move was a "one-time jolt" that should have lasting effects, Walters said.

"I’ve been trading mortgages for 20 years and you don’t see many days when one thing moves rates like this," said Walters. "You’ll see a pickup in demand for housing."

Still, stricter mortgage qualifications and growing job losses in a weakening economy will continue to hamper the market, even if the Fed plan manages to keep rates lower in coming days, said Sam Khater, senior economist for First American CoreLogic in Tysons Corner, Virginia.

"The market right now is not about rates, which are affordable, but about a supply of homes that is very high," Khater said in an interview. "The market won’t turn around and prices won’t stabilize until supply and demand become more normal."

The inventory of existing homes for sale in the U.S. rose to a 10.2 month supply in October, from 10 months in September, the National Association of Realtors said in a Nov. 24 report. In 2007, the supply averaged 8.9 months, almost double the 4.5 months in 2005, the end of a five-year housing boom.

The Fed plan "is one of the key actions we’ve been advocating ever since the Treasury altered its course on how it would use the $700 billion recovery package," said Charles McMillan, president of the Chicago-based Realtor’s group.

The Troubled Assets Relief Program, known as TARP, was approved by Congress and signed by President George Bush on Oct. 3. It gave Treasury Secretary Henry Paulson authority to buy assets after he told lawmakers he wanted to try to clear the market of "toxic" securities containing subprime mortgages.

Paulson used most of the first half of the TARP funds to buy equity stakes in troubled banks and in insurer American International Group Inc. On Nov. 12 he told Congress he wanted to use the second half to relieve pressure on consumer credit.

The Fed plan, in contrast, is focused on buying securities backed with "safe" mortgages that conform to the strict underwriting guidelines of Fannie Mae and Freddie Mac, according to Credit Suisse’s Soss.

"These are not the assets that have caused all the trouble - - these are quality mortgages that have been orphaned because investors have been reluctant to part with cash," said Soss. "The beneficiaries will be people who are buying or selling a house, because mortgage money won’t be as scarce."

Fannie and Freddie have about $1.7 trillion of corporate debt outstanding and $4.1 trillion of mortgage-backed securities.

"This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally," the Fed said in the announcement it posted on its Web site.

Consumers need all the help they can get to pay off their financial obligations.

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