Ben Bernanke: Fresh Attack on Mortgage Rates

Fed says it may begin buying long-term Treasuries.

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Fed Chairman Ben Bernanke on Monday opened the door to another unconventional measure to lower mortgage rates: buying long-term Treasury bonds.

In a speech in Texas Monday, the Fed chief said:

Although conventional interest rate policy is constrained by the fact that nominal interest rates cannot fall below zero, the second arrow in the Federal Reserve's quiver--the provision of liquidity--remains effective. Indeed, there are several means by which the Fed could influence financial conditions through the use of its balance sheet, beyond expanding our lending to financial institutions. First, the Fed could purchase longer-term Treasury or agency securities on the open market in substantial quantities. This approach might influence the yields on these securities, thus helping to spur aggregate demand.

By purchasing such securities, Bernanke is hoping drive down yields on long-term Treasury bonds, such as 10-year Treasuries. That would bring mortgage rates lower--since 30-year fixed mortgage rates typically track the yield on the 10-year Treasury note.

The bond market already began moving in the direction Bernanke had hoped:

From Bloomberg:

Treasury prices rose on Bernanke’s remarks, with yields on 10-year Treasuries tumbling about 10 basis points to 2.74 percent and two-year notes dropping to 0.85 percent. One basis point is equal to 0.01 percentage point.

The development comes less than a week after the Fed said it would buy hundreds of billions of dollars in Fannie Mae’s and Freddie Mac’s debt and mortgage-backed securities. The announcement appears to indicate that the Federal Reserve sees lowering mortgage rates as a key way to resolve the housing crisis.

 Some thoughts:

1. Could this bring mortgage rates lower? Sure. A big buyer like the Fed could push 10-year Treasury yields lower, which should result in lower fixed mortgage rates. But 10-year Treasury yields are already very low. It’s the fear in the market that is keeping mortgage rates higher than they otherwise would be. Until these “risk premiums” come in, mortgage rates will remain higher than they should be relative to 10-year Treasury yields.

2. What will that mean for the housing market? Less than you would think. Lower rates will enable some borrowers to refinance out of adjustable and into fixed-rate loans. But those who need to refinance the most have homes with negative equity, so they won’t be able to refinance. And while lower rates may convince some folks that it’s a good time to buy a house, only borrowers with good credit, a job, and a down payment will be able to get the lowest rates. With the economy in what many expect to be a nasty recession, borrowers fitting that profile are growing more difficult to find.

3. The verdict? While the Fed’s recently announced efforts to lower mortgage rates could help the housing market at the margins, it’s not a game changer. (And remember, all the Fed said today was that it might buy long-term Treasuries. It hasn’t formally said that it will do so.)


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