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Old 05-31-2009, 07:33 PM   #1
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Default Fed Mortgage Efforts Prove Costly

* JUNE 1, 2009

Securities Purchases 'Under Water,' Seem to Have Transitory Effect on Rates


The U.S. Federal Reserve's program to keep mortgage rates low by buying securities and Treasury bonds so far has been costly and seems to be having a fleeting impact.

An analysis of the timing of the Fed's purchases of mortgage-backed securities by J.P. Morgan Chase & Co. shows the Fed is "under water" on its portfolio by about 10%, and it would have to take about $5 billion in losses if it were to mark its portfolio to the market.

Since last autumn, the Fed has purchased more than $480 billion, out of an allowance of $1.25 trillion, in mortgage-backed securities and more than $130 billion, of $300 billion, in Treasury bonds to help keep mortgage rates low. Keeping rates low lets people refinance their mortgages to reduce payments and stay in their homes. It also encourages them to consider snapping up bargains in the still-ailing housing market. Many analysts believe the Fed plans to hold these securities until they mature in 10 years or so, with no plans to sell them into the market, so the losses will probably never be realized.

The central bank owns the majority of securities sold in 2009, with interest payments of 4%, 4.5% and 5%, according to J.P. Morgan's research. As interest rates rise, the value of these securities falls because new bonds are backed with higher-interest mortgage loans and thus pay higher coupons.

The Fed has spent about $2,500 per borrower, by J.P. Morgan's analysis -- more than it costs a typical mortgage borrower to refinance their debt. Higher fees and adjustments based on a borrower's credit score or home's value have been an impediment to borrowers looking to refinance a mortgage, damping the refinancing wave the Fed hoped for, analysts say.

The Fed's purchases have enabled about two million borrowers to refinance who otherwise wouldn't have been able to, J.P. Morgan estimates.

In addition to spending at a rapid clip, the Fed is confronting stronger resistance in the bond markets that set consumer rates as investors worry about inflation, the U.S. budget deficit and the practice of buying debt to stimulate the economy and keep interest rates down, called quantitative easing.

"The Fed's purchases have had only a transitory impact," said Thomas Atteberry, a partner and portfolio manager at First Pacific Advisors LLC.

Last week, the average 30-year mortgage rate rose from about 5% to at least 5.25%, by most estimates, reaching as high as 5.5% for some lenders late in the week. Earlier this year, it was steady around 4.8%. Its recent peak was 6.5% last autumn.

"If mortgage rates remain at this level, refinancing activity will have dropped by half within two weeks," said Mahesh Swaminathan, an analyst at Credit Suisse.

With rates at 5.25% or higher, 43% of borrowers with mortgages outstanding can cut their costs by about 0.70 of a percentage point by refinancing, a savings level that encourages a borrower to go through the process, according to Credit Suisse research. When the 30-year mortgage averages 4.75%, about 87% of borrowers are enticed to refinance, said Mr. Swaminathan.
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