NEW YORK (Reuters) - The Federal Reserve's $600 billion boost for the U.S. mortgage bond market, announced on Tuesday, may finally bring down the high home loan rates that have defied other efforts to stem the housing slump.
Since July, the U.S. Treasury and the Fed have increased their support for mortgage giants Fannie Mae and Freddie Mac, arguably the most important cogs in the U.S. mortgage market since they own or guarantee some $5 trillion home loans.
But effective guarantees from the Treasury, after a government rescue of Fannie Mae and Freddie Mac in September, have been no match for the deepening credit crisis that has weakened demand for the debt and mortgage-backed securities (MBS) issued by the two main home loan financiers.
The Fed on Tuesday said it would confront the problem with $500 billion in MBS purchases which should help to lower home mortgage rates, helping to buoy housing demand, and address the root of the crisis that is undermining U.S. economic growth.
The Fed's move on Tuesday had an immediate effect, with the 30-year mortgage rate plunging about 0.75 percentage point to 5.5 percent, according Bankrate, Inc.
BestInfo, Inc., a Dover, Vermont-based mortgage data company, said the rate fell 0.625 percentage point, to 5.375 percent.
"They are getting to the heart of the (housing) problem -- it's clean, it's quick, it's direct," said Todd Abraham, co-head of government and mortgage assets at Pittsburgh-based Federated Investors, Inc. which invests $344 billion.
"It's a good way to bring down mortgage rates."
The Fed's purchases apply to securities issued by Fannie Mae, Freddie Mac and Ginnie Mae, which finance the bulk of home lending in America by packaging loans into bonds, stamping them with a guarantee, and selling them to investors.
The Fed will also buy up to $100 billion in debt of Fannie, Freddie and the Federal Home Loan Banks which use proceeds to buy mortgages for themselves or make loans to banks.
Mortgage rates have dropped after a host of weak economic data signaled a U.S. recession and pushed U.S. Treasury yields to 50 year lows. But home loan rates could have been even lower if investors demand for MBS was higher, analysts said.
The average 30-year mortgage rate at 6.16 percent in mid-November represents a gap of nearly 2.5 percentage points above the benchmark 10-year note, a premium of nearly three-quarters of a point more than a year ago.
That premium began to shrink with the Fed purchases announced on Tuesday, allowing mortgage rates to drop to 5.5 percent, a level that in January sparked the largest wave of refinancing in nearly five years, said Greg McBride, senior financial analyst at Bankrate in North Palm Beach, Florida.
Purchases of the "agency" bonds and MBS are expected to take place over "several quarters," the Fed said.
"This plan is designed to have some staying power to it," McBride said. "This is not a situation like we saw in January of this year, where mortgage rates plunged to 5.5 percent but stayed there only for a matter of hours."
The move may be an admission that the government's conservatorship of Fannie Mae and Freddie Mac failed to lower U.S. mortgage rates.
The two companies now have sufficient capital at least through 2009, but investors have questioned the future of the U.S. government support that led to greater risk taking and $1.6 trillion in debt.
Direct Fed purchases of MBS eat into the domain of Fannie Mae and Freddie Mac, which have long dominated ownership of the bonds they issued. But after crippling losses that may cost taxpayers, officials including Timothy Geithner -- named by President-elect Barack Obama as Treasury secretary-- have said the models of Fannie Mae and Freddie Mac are due for a change.
So the Fed has turned to manipulating mortgage rates amid months of frustrating efforts to shore up the U.S. housing market. Efforts by banks to ease loan terms for borrowers have so far failed to stop the vicious cycle of foreclosures and falling home prices that have turned away prospective buyers.
"It's very clear that the government wants to send a signal that they are standing behind housing," said Alfred DelliBovi, president of the Federal Home Loan Bank of New York.
"I hope that the effect is that it brings more investors home to investing in housing," he said. Investors "have had a sense in the markets that anything connected with a mortgage is bad" even though most people pay their loans, he said.
The two year U.S. housing slump has infected the economy causing rising unemployment, falling business investment, and weaker consumer spending. The U.S. economy shrank more severely during the third quarter than first estimated as consumers cut spending at the steepest rate in 28 years, the Commerce Department said on Tuesday.
By stimulating a home refinancing wave, the Fed can redirect cash currently tied up in mortgage payments to the economy. Lower rates can have an indirect effect of at least slowing home price declines, said Keith Gumbinger, vice president at HSH Associates, a Pompton Plains, New Jersey, data company.
"If you don't have to send $1,000 a month to your mortgage lender but only $900, you've got $100 a month to go stimulate the economy," Gumbinger said. "That's probably as, if not more important, than stimulating home buying."
(Additional reporting by Julie Haviv)