Fed plan not a housing, mortgage market cure

By Lynn Adler - Analysis

NEW YORK (Reuters) - A central bank plan to infuse the financial system with new cash is a temporary fix for the debilitated U.S. mortgage bond and housing markets, but not a cure.

The program announced by the Federal Reserve on Tuesday frees up money for mortgage loans and dealer bond buying in the two markets paralyzed by limited funding and fears of bank failures, economists and analysts say.

"This is a tourniquet, it will staunch the bleeding, but it may not turn us around and bring the patient to health," said Susan Wachter, real estate and finance professor at The Wharton School, University of Pennsylvania.

Tighter lending standards, dried up funding and record foreclosures are swelling the supply of unsold homes in the worst U.S. housing market since the Great Depression.

"This is designed to stop in its tracks what might otherwise be an old fashioned credit crunch where the banks simply themselves seize up," Wachter said. "It's not a sure fire end of the crisis by any means."

The Fed will let dealers use U.S. agency debentures and agency mortgage bonds, as well as top-rated private label mortgage securities as collateral in the new lending facility.

This will be the first time the Fed takes non-agency residential mortgage bonds as auction collateral in its latest effort to add market liquidity. It already accepts this kind of paper as collateral from banks that borrow directly from the U.S. central bank at the discount window.

The initial $200 billion funding for the plan might be raised, according to the Fed. The size of the plan pales in comparison with the mortgage bond markets totaling more than $7 trillion.

Historically high defaults and foreclosures froze mortgage lending to all but the highest quality borrowers, and closed many companies who relied on higher risk home loans.

Trouble that shut down the subprime mortgage sector has now started cascading to higher-quality loans, leading to a growing number of private and federal plans to restore order in the mortgage bond and housing markets.

The Fed said that the private-label MBS it would accept must be AAA-rated and could not be on watch-list for rating cuts. Possibly $1 trillion of those securities were eligible, according to senior Fed staff members.

The market for private label bonds, or those backed by mortgages too large for Fannie Mae and Freddie Mac to buy, was stung too as lenders and investors grew more risk averse.

A recent government plan to sharply, but temporarily, raise the size of loans those top two U.S. home funding companies purchase should also provide at least short-term relief.

The Fed is "buying time" by unfreezing markets for some highly illiquid assets, said Dr. Robert A. Eisenbeis, chief monetary economist at Cumberland Advisors and former Atlanta Fed executive vice president. "But liquifying those assets does not mean the funds will flow back into mortgage markets."

SWIFT RESPONSE