Countrywide stress may stir Fed's resolve on rates

By Al Yoon - Analysis

NEW YORK (Reuters) - Severe financial disruptions now touching Countrywide Financial Corp., the country's biggest mortgage lender, may set the wheels in motion for an interest rate cut by the Federal Reserve, analysts said.

Countrywide CFC.N, which provided nearly one in five U.S. mortgages this year, on Thursday said it tapped an $11.5 billion credit line, confirming speculation that a draconian pullback by investors has stressed the company that two weeks ago claimed its access to capital was "highly reliable."

The reach of Countrywide expanded in 2007 as it took employees and market share from fallen rivals whose loose lending standards deepened the housing slump.

This larger presence in the national economy cannot be ignored by central bankers who have so far been reluctant to show alarm over a snowballing mortgage crisis, analysts said.

"The Fed would not react to bail out Countrywide, but it would have to react to the possibility that the fate of a company like that could bring the economy to its knees," Lyle Gramley, senior economic advisor with the Stanford Group Co. and a former Federal Reserve governor, told Reuters.

A failure of the $11 billion company run by mortgage veteran Angelo Mozilo may have deeper impact than other companies deemed as "too big to fail." analysts said. As a banker, lender, securities broker-dealer and insurer, it has a more tangible relationship to consumers than the infamous hedge fund Long-Term Capital Management that won a Fed-organized $3.6 billion bail-out by its creditors to avoid collapse of the financial markets.

The Calabasas, California-based company originated $245.1 billion of home loans in the first six months of this year, a 9 percent jump from last year, according to Inside Mortgage Finance. Its market share bulged to 17.4 percent, IMF said.

"Are they the institution that is too big to fail and the one that the Fed says 'We must defend?'" said James McGlynn, a Southlake, Texas-based portfolio manager with Summit Investment Partners. "If (the Fed) doesn't step in, I don't see (the crisis) not spreading."

Financial markets which stand to benefit from a cut in the Fed's federal funds rate think differently. U.S. short-term interest rate futures were sharply higher on Thursday, showing traders have sharply boosted bets that the Fed will cut the 5.25 percent funds rate by as much as 0.5 percentage point in September.

Mortgage strains that began with subprime, or the riskiest, loans has since May spread to lenders that specialize in higher quality loans and whose diversity was thought enough to absorb losses. Signs that defaults all but top-tier loans continue to rise has led investors to pull their support for mortgages, and by extension banks pulling back on support for lenders.

Like many lenders, Countrywide thought the subprime crisis was contained. Less than 10 percent of Countrywide's 2006 loans were subprime, it has said.

The squeeze on credit to mortgage lenders and companies worldwide has been only acknowledged by Fed officials who have been unshaken in their belief that the economy remains strong enough to feed inflation and withstand isolated shocks.

Federal Reserve Bank of St. Louis President William Poole on Wednesday said it was too early to say the "upset" in the market warrants an emergency cut to short-term interest rates.

Only a "calamity" that has the weight to change the course of the economy could call the Fed to action, Poole said.

"Until (Fed officials) see evidence -- and this isn't it -- that distortions in financial markets are going to affect the stability of the economy and inflation they are not going to cut rates," said Stephen Cecchetti, an economics professor at Brandeis University and a consultant to the European Central Bank.