Time for the Fed to start manipulating mortgage rates?

If you could refinance your mortgage at a 4% fixed rate, you could probably save a bundle, right?

Veteran Wall Street economist Ed Yardeni says it's time for the Federal Reserve to engage in direct market manipulation of long-term interest rates, pulling them down in order to get conventional home loan rates down.

Yardeni, who heads Yardeni Research in Great Neck, N.Y., says that with the housing market still falling fast and the rest of the economy going along for the ride, a global depression is a real risk.

The Fed has slashed its benchmark short-term interest rate to 1% over the last year, he notes, with little or no effect on most long-term interest rates.

Yardeni is calling for the central bank to launch a program that Chairman Ben S. Bernanke discussed publicly in 2002, before he took the Fed's helm. If the economy ever faced a serious deflation threat, and the Fed had already cut short-term rates to zero, policymakers could turn their focus to directly influencing long-term rates, Bernanke said at the time.

This was the famous "Helicopter Ben" speech, for the imagery of a helicopter drop of money into the economy.

Under Bernanke's plan, the Fed would try to manipulate long-term rates by buying long-term Treasury securities for its own account. That's what Yardeni proposed in an email he sent to clients late last week.

I'm not quite convinced this would work as Yardeni sketches it out; for one thing, I wonder who, other than the government itself, would be willing to make and hold 30-year mortgages at 4%. Plus, there inevitably are unintended consequences in attempts to manipulate markets.

In any case, I wanted to share the highlights of his proposal, for discussion's sake.

Here are some excerpts:

The Fed can end the credit crisis today. Chairman Bernanke and his colleagues simply need to announce that the Fed will peg the 10-year Treasury bond yield at 2.0% [down from a market yield of 3.17% on Friday]. This should pull down the 30-year fixed-rate mortgage yield from about 6% now to 4%, possibly lower. That would revive housing sales, home prices, and mortgage refinancing.

The Fed can buy 10-year Treasury bonds with the announced goal of lowering the yield on these securities and pushing down the fixed-rate mortgage rate, which tends to trade off the 10-year Treasury. That's because the average maturity of 30-year mortgages tends to be between 5-10 years as people move and prepay.

How will the Fed pay for the bonds? The Treasury will continue to borrow the funds in the Treasury bill market at rates currently near zero and deposit the proceeds at the Fed. It has been doing so since mid-September to fund the expansion of all the new liquidity facilities established by the Fed to unfreeze interbank lending and money markets. Unfortunately, none of these have done much to open up the mortgage market, which remains in a deep freeze.

The Fed would most likely need to purchase a very small fraction of [outstanding bonds] to peg the 10-year yield. It is very likely that the Fed's purchases would produce capital gains in all sorts of bonds, including mortgage-backed securities, as well as corporate and municipal bonds.

Lower mortgage rates would allow many homeowners to refinance their mortgages. That's what happened after the last recession, with the monthly windfalls helping to boost consumer spending. There is probably enough pent-up demand to significantly reduce the inventory of new and existing unsold homes, which is currently around 4.5 million units, as would-be home buyers respond to the incentive of lower and more affordable mortgage rates.

What if lower mortgage rates don't revive housing activity because lenders are less willing to lend because unemployment is rising? To get out of this "liquidity trap," the Treasury could borrow $1 trillion in the T-bill market and fund a first-come-first-served 4% mortgage sale implemented by Fannie Mae and Freddie Mac with their huge national network of mortgage originators. That should finance up to 5 million home purchases. Americans always respond well to sales. It can be called the Home Recovery Program (HRP).

The best way to remove troubled mortgage assets from complex fixed-income securities and derivatives is to have the borrowers refinance their mortgages. The fairest and most efficient way to do this is with the HRP approach.

There are those who say that housing is going through a necessary "correction." That might explain why the Fed hasn't done more to revive the housing and mortgage markets. It is obvious by now that Mr. Bernanke and his colleagues must act immediately before the housing correction turns into a global depression.

Comments

[mr.bilko]

Yardeni failed basic business math. Cheaper interest leads to price inflation. This is what happened in the housing market between 2002 and 2007. The historical rate for a 30 yr fixed mortgage is between 8% and 9%. What Yardeni is proposing is to create another real estate bubble as an antidote for the previous real estate bubble. California, Nevada, Arizona and Florida are the main states that have been nailed in the current real estate fiasco. The rest of the U.S. has corrected to prebubble levels. If Yardeni's 4% rate could happen, real estate selling prices rise by 20% to 50%. The monthly payments stay the same but the selling price explodes, just like between 2002 and 2007.

[martscan]

There is nothing wrong with Yardeni's math. In a crisis of this magnitude, with deflation a very real threat, you deal with the problem at hand and cross bridges when you come to them. With the Fed Funds rate where it is, the Fed and Treasury would love to be faced with beating inflation...rather than what they've got. If these capital infusions into lending institutions are tied to certain amounts actually being lent...we can then tackle the housing skid. Arresting the slide in housing is absolutely essential before any economic recovery can possibly take place.

[frank alvarez]

I've been telling anyone who'll listen this same idea for months now. Trickle down bailouts will not work. Something has to get the consumer moving again and 4% interest rates will do just that.

[JS]

Why is deflation considered a threat? Why, other than for the grand purpose of economic theory, is continual economic growth considered the benchmark by which we measure our progress?

Deflation is really nothing more than an expression of prices relative to each other over time.

Economics 101 - consumer spending drives the economy. Anything we do that raises the costs of what we spend our money on reduces our spending power, which by extension, means salaries must rise to maintain our spending power. It believe the technical term is "vicious circle".

If housing climbed 100% in 5 years, and has now retreated 40% from the peak, we are still 20% above the base - hardly cause to jump out of windows. Would it be so bad for the population long term if housing dropped another 40%?

We need to change the mindset in this country, the concept of ever escalating prices, salaries, revenues and dividends is simply unsustainable - particularly in light of global competition.

We can raise salaries to meet the inflationary prices, or we can deflate prices to meet affordability. The latter may be a very tough pill to swallow in the short term, but ultimately will be the best bet.

Those that bought in the last 6 years will be penalized, certainly, but they too will achieve a better net standard of living 10 years from now, as they will now make payments on a $200,000 mortgage instead of a $300,000 one, on the same home.

The preservation of current home prices is economic suicide, and will saddle our great grandchildren with a lifetime of servitude to the tax man to pay for our short-sighted mistakes.

[dsinha]

Yardeni is spot on. The artificially lower mortgage rates would unfreeze needed liquidity among consumers and give the economy the jolt it needs. The real estate bubble of the last decade was created by a COMBINATION of cheap credit and lax lending standards.

Cheap credit, with tight control on risky borrowing will go a long way towards keeping people in their homes, reducing inventory, and jump starting the economy.

Once the economy rights itself, the program can be carefully revised.

[morpheus]

I agree that the crisis is big, but we must be careful not to create another bubble that we will have to deal with later. The proper approach here would be to separate refinancing rates from purchasing rates. Let home owners refinance with affordable rates, around 4%, and let the new purchases still go under the market rates. This way Fed would be able to deal with the foreclosure crisis without risking another housing bubble.

[martscan]

I suspect there are contributors on this site that confuse their taking Econ 0.0101, and its text requiring the jumbo box of Crayolas...with Econ 101, which young grown-ups study.

[el]

We've already have artificially low mortgage rates. The mechanism since the early 70s has been called Fannie Mae and Freddie Mac.

Deflation in itself will not be the cause of economic stagnation. Rather, deflation is a symptom of non productive industries and falling demand as a result of unemployment and reduced. The only way to revive consumption is to provide this stability. Business' have to become cheap enough so that profitable hiring can occur again.

Anyways this is what happens when all your eggs are in one basket. For the US the basket is called the leveraged consumer industry.

[marc]

the first comment is excellent but you can bail out our economy with this method by capping the house market with appriasal services so the cost does not go up by twenty percent.

[D. Marble]

Cutting interest rates is one part, they also need to cut capital gains tax to 10% and the Corporate tax rate to 12%, and make the USA a "right to work" county. Boom goes the economy, business could afford to stay here, and we all live to play another day.

[JS]

Martscan - good response to my post. Shows a deep intellectual capacity.

An economy driven by credit spending is unsustainable, and obviously why we're here now. To make more credit available as a cure is like fixing a broken leg by breaking an arm.

Rather than snipe from the sidelines, why don't you explain why lower home prices over the long term is bad for America? Why would lower personal debt loads be wrong? Why would a reduction in America's "cost of goods sold" make us less competitive on the world stage?

Access to cheap credit distorts the value of the underlying asset. It's no longer a "what's it worth" process, replaced with a "can I afford it" mentality. It was the problem that got us here, and it sure as hell isn't going to get us out.

As alluring as this proposal of Yardeni's is, it fails to address the underlying problem. If, as you assert in your first comment, we should "deal with the problem at hand and cross bridges when you come to them", I would submit that your view of the "probelm at hand" is much more limited than mine.

[Brenda K]

I too have been saying this needed to been done since the first of this year. I believe that if it had, we wouldn't be in the position we are in today. Many of these homes that have foreclosed this year would have been sold to qualified buyers with down payments, thus replacing bad loans with good loans by people that would have equity in the homes along with a great mortgage rate that they knew they probably would never get again, all the incentive needed to hold onto that home. The lower rates would spark buying which would eat up the excess inventory and bring on the bottom to falling home prices, that have fallen already to pre-bubble levels in many areas.
This really needs to be done, as falling prices alone have not sparked any demand in housing whatsoever, and at the rate we are going, the more home values drop, the more foreclosures will rise, and banks will need bailout after bailout to stay in business.

[Mr. Milani]

Interest rates are already very low and have been for years.
I should know, I am a loan officer in Ohio and interest rates are not the problem, and lower rates will not help if housing values are down and peolpe owe more on their home than they are worth, how in the world are they going to refinance?
The vaule must be there or refinancing is not an option.
what the Fed needs to do is give that $700 billion dollars to tax payers who's houshould income is below $250,000 annually.
With tens of thousands of dollares infused into the publics pocketbooks, the first thing they are going to do is spend it or maybe invest it or save it.
If we spend it, we will buy cars, houses, products and services - which in turn will fuel the economy.
If we invest it - it will boost the stock market.
If we save it - it will help the banks
why give money to the very institutions who screwed this whole thing up from the start.

[moshe kerr]

The problems are far more complex than this idotic band aid presents. The passage of the Federal Reseve into law in 1913 established America as being a partner with the Bank of England. It legalized a banking cartel, effectively negating the Sherman Anti Trust Act of 1890. Once American leaders abandonded the Constitution and Declaration of Independence, the domino effect began.
Today the US economy Corporate Cartels dominate. The authority of lobbies has more sway than does elections. The industrial military complex, drug industry etc when the Washington bureaucratic machine runs mind boggling deficits, these power brokers demand and get more and larger portions of public money at the nations' expense. Now America fights endless fruitless wars, has foreign military bases scattered all over the world. During an economic crisis unprecidented in the times of this generation, Presidential candidates debate, as if it were a priority, foreign affairs. Well for the lobbies and IMC, these vanities bear supreme importance toward maintaining the American Empire.

The problems facing our nation involve much more than possible policies taken by the "Fed". Washington has abandoned public trust. Until the legalized corporate cartels recieve the identical treatment as the "war on drugs", until Washington through law makes all Cartels, banking, medical, military etc, illegal, the crisis of confidence shall not cease.

[David]

I think Ed is right on.... This will be like an ongoing fiscal stimulus that can last for many years and helps everyone who has a home and also those that may want one since they can get a lower interest rate...

[Tom Petruno]

Folks: Note that what the Fed did on Tuesday, in agreeing to buy up to $500 billion of mortgage-backed bonds of Fannie Mae, Freddie Mac and Ginnie Mae, is a more direct route to pulling mortgage rates down than what Yardeni suggested (which was to buy long-term Treasury bonds). It's the same basic idea, though: Use government money to try to force market interest rates in a particular direction -- in this case, down. It appears to have had an immediate effect in the mortgage market, as lenders slashed rates on conventional home loans. A Fed plan to buy Treasury bonds conceivably would have had a broader effect on long-term interest rates, but for now the Fed must be happy with the market reaction.

Tom Petruno

[martscan]

JS:

Since you challenge my broad, generic remarks directly, you now afford me the right to disabuse you of your ridiculous, inane comments which have not even a semblance of economic logic...theoretical or otherwise.

That you would implicitly ascribe certain claims arising from my comments is reprehensible... in any intelligent debate. For example, no where have I stated that "lower home prices over the long term is (sic) bad for America", nor have I said that "...personal lower debt loads be wrong". And where in the hell you came up with my implying that a "... reduction in America's 'cost of goods sold' make us less competitive on the world stage?"...is beyond me.

While ordinarily I would be pleased to counter your arguments, point by point, it is enough to say that anyone who doesn't realize what a credit freeze is, who would fight inflation by raising salaries, who has no conception of deflation and aggregate demand and purposes of monetary policy...well, it'd be an exercise in futility.

[john dough]

Deflation is NOT happening. Deflation is a DECREASE in the money supply. Not sure what planet you guys are on but the money supply is up 100% in 3 months - a new record. And the $7 TRILLION in bailouts and proposed bailouts, injections, whatever you want to call it - will cause MASSIVE inflation in due time - most likely beginning in 2009.

To the idiote who thinks there's another 40% reduction coming in home prices - think again. We're already well below pre-bubble pricing, we just have a petrified consumer too afraid to make a move. They call this the pendelum swinging too far, and that's where it's at.

A repeat of the Carter years is beginning to unfold - a Dem promising change, - a shittton of new money and 'stimulus'. The Fed has made it very clear - they will INFLATE this economy at all costs. This will prop up housing, and this will de=value the debt they are taking on. You think the Fed would allow government debt to become HARDER to pay off? Not quite. They will devalue the crapola out of it through money supply going to the stratosphere.

Inflation is right around the corner folks, and the almighty USD is about to take an intentional hit in 2009 as this unfolds. Get ready for 20,000 on the DOW and home prices to spike upward once again - along with everything else. And oil, well, the $50bbl is about as short-lived as the $150bbl was. We'll be over $100 again in no time, so get off your arsses and prepare.

Commodities, real estate, and equities (picked right) will be a safe haven in 2009-2012. While the morons are crying about being afraid and about this TEMPORARY deflation (of only a few assets), the real agenda is being cranked out behind the scenes. Go ahead, bail on your homes - someone smarter than you will pick it up cheap, hold it for a few years, then sell it for a nice profit.

[Michelle]

I'm going to take it a step further and say the fed should somehow get banks to allow these refis with no regard to current equity. Just let everybody refi that wants to, charge a small upfront fee to weed out the deadbeats and let people refi at 4%. that will keep people in their homes. Right now nobody can refi that bought in the past decade, seriously.