Fed engineers mortgage rate cuts, refinancings

By Al Yoon and Lynn Adler - Analysis

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 drop was a more pronounced 1.125 percentage points, to 4.875 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."