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Fed Faces Mortgage Challenge

Posted on Nov 25, 2008
Escape Forelosure

The mortgage market got a lift following Tuesday’s announcement that the Federal Reserve was throwing in with a $600 billion resuscitation bid, but as Fortune’s Colin Barr points out, history offers at least two examples that the road ahead could be rocky.

Fortune via

The Federal Reserve said Tuesday morning it would spend $600 billion in coming quarters to buy the bonds and mortgage-backed securities issued or guaranteed by Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500). The move, the Fed said, aims “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 market reacted positively to the announcement, with the spreads between the yields on agency bonds and similar-duration Treasury securities narrowing. Lower spreads translate to lower mortgage rates, which bring down the cost of buying houses. That generally leads to more house sales—a top priority for officials who want to slow the decline in house prices that is soaking financial-sector balance sheets with losses.

The decision to buy agency debt and mortgage-backed securities shows policymakers are “looking to drive mortgage rates down,” says Bill Larkin, a fixed-income portfolio manager at investment adviser Cabot Money Management in Salem, Mass. “They need to get them close to 5% if they want to get the housing markets going again.”

That will take some doing, though. The rate on a 30-year fixed mortgage was around 6% Monday, before rates fell Tuesday on word of the Fed plan. The lowest rate on record since the St. Louis Fed started tracking conventional 30-year mortgage rates was the 5.23% reached in June 2003, in the midst of the housing bubble that inflated earlier this decade.

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