What Will the Fed Do Now That Rates Are at Zero?

The Fed has been attempting to resuscitate the deflationary housing market through traditional monetary tools, but recently it ran out of ammunition when the Federal Funds rate dropped to zero. The traditional methods of manipulating money supply have been exhausted-open market operations, the discount rate, and reserve requirement. These conventional tools are aimed at affecting the short term rates with the hopes that the longer term rates will also adjust accordingly. The hopes never materialized and this left the 30 year fixed mortgage rates stubbornly high relative to the three month T-Bill.

The Fed then moved to an unconventional monetary tool called quantitative easing. Quantitative easing is the attempt to loosen the credit markets by purchasing bank assets that are priced at the long end of the yield curve, such as mortgage backed securities. The only precedence for this technique in modern history was Japan. They used quantitative easing to help prevent deflation after their overnight interbank lending rates dropped to zero during the 1990s and early 21st century.

The Fed’s unconventional technique has worked in helping lower the mortgage rates. Recently, the 30 year fixed mortgage rate tested a 37 year low of 5.19%. The Fed has committed $100 billion and spent $15 billion thus far to purchase MBSs from Fannie and Freddie in the hopes of loosening up the mortgage markets to spur borrowing again. While the traditional monetary tools have proved ineffective, the Fed has targeted a different means of fulfilling its dual mandate of growth and price level: quantitative easing

Comments

[Moon Kil Woong:]

No what helped bring down the mortgage rates was the fact that no one is buying and banks have a hoard of cash with nothing to do with it. The interest rates were all pointing to Zirp long before the Fed lowered to Zirp.

Likewise, the lst thing the fed should be promoting is quantitative easing. First the US has a massive deficit already. If Japan couldn't even afford stimulating itself out of 0% interest rate deflation what are the odds we can? If anything 0% inflation tends to lead to more deflation.

Just because bankers have a lot of free cash from bailouts and the Fed buying their somewhat solvent loans for cash (probably at a loss) doesn't mean they are going to share the wealth, increase loans, or buy multi-million mansions for themselves allowing the trickle down theory to work. Nope, giving bankers money is like giving gold to scrooge. It will never appear again in the light of day.

Face it helicopter Bernake is dumping money in the one place it does no one any good; his friends.

2008 Dec 31 04:28 AM

[Invisible Hand:]

Buying properties doesn't bring mortage rates down. Objectively mortgage rates are based off of libor. Generally banks base it off the 10 yr libor and add 200 basis pts or use an average of the 10 year treasury plus 200 basis pts. What creates the libor rate is demand and supply for loanable funds. When the securitization market seized up in sep and october, the supply of loanable funds sharply decreased forcing the cost of borrowing up. Demand also fell but not at the same rate as supply. The avg mortgage rate in sep was 6.04 in Oct it jumped to 6.2. After the Fed made a commitment to purchase MBS from Fannie and Freddie in late October/early Nov. the liquidity "expectations" reemerged dropping rates to its current level.

The Fed funds rate can influence the mortgage rate during healthy times,but during times of financial crisis they don't normally follow as closely. For example, during the last recessin the fed brought the discount rate down, but the mortgage rates didn't reflect this added stimulus.

The Fed is attempting to restore confidence back into the MBS market. They are literally planning on doing this by buying MBS. As you know there is an inverse correlation between bond prices and yields so when the Fed buys MBSs it increases the bond price and lowers the yield on these MBS. The lower yield helps increase confidence and liquidity in the loanable funds market.

With all this said, you can lead a horse to water, but you can't make it drink. On both the consumer and business side, no matter how cheap the cost of money gets, people still need to take risks and not enough people are willing to do this.

2008 Dec 31 10:40 AM

[Invisible Hand:]

Let me clarify with the info on mortgage rates. Adjustable mortgage rates are based off libor and the 30 year is based off the 10 year treasury. Also there is no 10 year libor..typo. Libor is a short term metric of interest rate risk.

2008 Dec 31 01:48 PM

[Gedankonomist:]

Banks don't have a hoard of cash. Look into what "fractional reserve system means."


On Dec 31 04:28 AM constructe wrote:

> No what helped bring down the mortgage rates was the fact that no
> one is buying and banks have a hoard of cash with nothing to do with
> it. The interest rates were all pointing to Zirp long before the
> Fed lowered to Zirp.
>
> Likewise, the lst thing the fed should be promoting is quantitative
> easing. First the US has a massive deficit already. If Japan couldn't
> even afford stimulating itself out of 0% interest rate deflation
> what are the odds we can? If anything 0% inflation tends to lead
> to more deflation.
>
> Just because bankers have a lot of free cash from bailouts and the
> Fed buying their somewhat solvent loans for cash (probably at a loss)
> doesn't mean they are going to share the wealth, increase loans,
> or buy multi-million mansions for themselves allowing the trickle
> down theory to work. Nope, giving bankers money is like giving gold
> to scrooge. It will never appear again in the light of day.
>
> Face it helicopter Bernake is dumping money in the one place it does
> no one any good; his friends.
>
>

2008 Dec 31 11:18 PM

[mrbill:]

On Dec 31 04:28 AM constructe wrote:

> Likewise, the lst thing the fed should be promoting is quantitative
> easing. First the US has a massive deficit already. If Japan couldn't
> even afford stimulating itself out of 0% interest rate deflation
> what are the odds we can? If anything 0% inflation tends to lead
> to more deflation.

Exactly! We need to do EVERYTHING to stop this deflationary horror nightmare! I say the Fed write each and every U.S. citizen a check for $1 mil. But seriously, THAT might not be enough !!! I say we go into negative interest rates. For ea. dollar loaned, they pay out 5 cents. What do you think?

Jan 01 08:14 PM

[neocon4jesus:]

I see the housing bottom taking place in Nov of 2012. For the next FOUR years, we are going to see not blood in the streets, but the patient slowly bleeding to death over time.

However, I do see the S&P dropping to 500 by the end of 2009.

CASH is king for the short term. And forget shorting, that game is rigged. Look at DIG and DUG for proof.

Jan 02 12:25 AM

[Moon Kil Woong:]

R Jensen. Look at the banks deposits to the Fed. They are parking their money at the fed for interest when they don't buy Treasuries. That is what I call a load of cash. I don't mean the physical thing per say, instruments that trade essentially as cash tucked away by them. They are awash in it. Look at M1 money supply.

Jan 02 01:04 PM

[Invisible Hand:]

With the 30 year mortgage rate coming down this does show that banks and investors are willing to take some risk. The spread between the 10 year treasury and the 30 year mortgage is still rather high; today it's close to 3%; before the fall season it was at 2.5%; and historically during normal times it's between 1 to 2%.

Eventually we will return to a spread of 2.5%. For this to happen one scenario is that the 10 year bonds would sell off causing its yield to increase, and if mortgage rates would stay constant. The polar opposite would be bond yields staying constant and mortgage rates falling.

If the stock market improves due to the inauguration effect, we should see the first scenario in the short run; bonds sell off when stocks go higher. Inflation worries are another event that could trigger a sell of bonds. I'm not sure how much more mortgage interest rates can fall from here. Fannie and Freddie are supposed to sell MBS in the next week and this should be a tell for mortgage rates.

Jan 03 08:59 AM

[Visible Hand:]

constructe, you are an idiot. The invisible hand knows what he's talking about. You are probably a college dropout who thinks he knows everything. You should stop making stuff up and learn about the markets. You propably don't even know what caused the recession.

Jan 07 12:18 PM

[{+} SilenceU:]

On Jan 02 12:25 AM Donnie B Good wrote:

> I see the housing bottom taking place in Nov of 2012. For the next
> FOUR years, we are going to see not blood in the streets, but the
> patient slowly bleeding to death over time.
>
> However, I do see the S&P dropping to 500 by the end of 2009.
>
>
> CASH is king for the short term. And forget shorting, that game is
> rigged. Look at DIG and DUG for proof.

While it will bottom in the near future, i'm pretty sure it wont be that far away, but actually in the time of a few months. Seeing those hit with teaser rates, will be getting hit hard when their attempts to refinance starts this year up until 2011, so by the time we hit your prediction we will already be moving onward from that collapse.

Jan 09 10:31 AM