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The Fed story: Money for nothing, advice for free (With apologies to Dire Straits) (Updated)


According to the AFP ...

"The panic in global financial markets has sparked an unprecedented rush into safe US Treasury securities, driving yields on short-term government notes down to almost zero.
Due to stampeding demand for safe short-term investments, the US Treasury's four-week and three-month bills on Friday yielded an effective rate of 0.01 percent -- down sharply from 1.515 percent and 1.785 percent, respectively, in early September."

"Other Treasuries are also showing record low yields. The 10-year bond yield fell as low as 2.505 percent and the 30-year bond yield slid to 3.005 percent at one point on Friday. The six-month bond yielded a mere 0.20 percent. The low yields reflect a surge in demand for these instruments, seen as the safest in the world during times of turmoil."

Original blog entry ...

Money for nothing …

Capture11-27-2008-4.18.43 PM

Notice the abysmally low yields for Treasury bills. This is the same scenario which spurred the global pool of capital to seek a relatively safe, or so they thought, investment in mortgage-backed securities.

Unfortunately, when all of the creditworthy borrowers had a mortgage, the lending regulations were relaxed, and relaxed and relaxed – with the Wall Street Wizards thinking they were containing the risk using repurchase agreements and schemes involving credit default swaps. What nobody realized, while they were making money hand over fist,  was that the total amount of loan purchases with borrowed money and credit default swaps greatly exceeded the equity of most firms – and just a small downturn in the market or unavailability of counterparty buyers brought the whole game to a standstill.

Which is where we appear to be today. Most financial firms do not know the exact amount of risk or toxic assets on their balance sheets, so they refuse to lend. Especially to counterparties with the same situation: an unbelievable balance sheet. – Requiring governmental action by the Treasury Department and the intervention of the Federal Reserve to straighten out the tangled interlocking balance sheets.

Advice for free …

  • November 19, 2008

    Vice Chairman Donald L. Kohn: “Monetary Policy and Asset Prices Revisited” at the Cato Institute's Twenty-Sixth Annual Monetary Policy Conference, Washington, D.C.

  • November 18, 2008

    Chairman Ben S. Bernanke: “Troubled Asset Relief Program and the Federal Reserve's liquidity facilities” before the Committee on Financial Services, U.S. House of Representatives

November 14, 2008

Chairman Ben S. Bernanke: “Policy Coordination Among Central Banks” at the Fifth European Central Bank Central Banking Conference, “The Euro at Ten: Lessons and Challenges,” Frankfurt, Germany

  • November 12, 2008

    Vice Chairman Donald L. Kohn: “Productivity and Innovation in Financial Services” at the Official Celebration of the 10th Anniversary of the Banque Centrale du Luxembourg, Luxembourg, Luxembourg

  • November 6, 2008

    Governor Kevin Warsh: “The Promise and Peril of the New Financial Architecture” at the Money Marketeers of New York University, New York, New York

(Click on a date to read the wisdom of the Federal Reserve Chairman and his side men.)

In these speeches, everybody seems to be pitching their favorite solution, pointing their fingers at a variety of causal elements and ending with the obligatory promise that “we are doing the best we can.”

Quantitative easing … 

This is apparently the term being used to characterize the massive government intervention in the financial markets. 

“Yield on 10-year Treasury debt below 3%”

“Financial markets notched up another historic milestone on Wednesday as the yield on 10-year US Treasury debt fell below 3 per cent for the first time in 50 years.”

“The decline in yields – to a low of 2.98 per cent – comes in response to unconventional policy measures taken by the US Federal Reserve this week aimed at pushing short-term and long-term interest rates lower.”

What is going on …

“This so-called ‘quantitative easing’ is a strategy central banks use to fight deflation, the dreaded combination of declining growth and falling asset prices.”

“ ‘It is astonishing [that yields are so low],’ said Michael Chang, interest rate strategist at Credit Suisse. ‘The current environment is not like anything we’ve seen before. The Fed’s being very aggressive in quantitative easing, and the fall in yields is the result.’”

Inflation seems to be contained …

Capture11-27-2008-5.58.06 PM

As we can see, inflation seems to be contained as it would take a 1.47%, 1.9% or 2.52% rise in the federal funds target rate to reach a neutral inflationary stance in a 5-year, 7-year or 10-year outlook; respectively. This looks fairly good at this time. Note: it is possible that the Federal Open Market Committee will once again reduce rates in their December 16th meeting. 

Something seems to be working …

“Almost immediately after the Federal Reserve announced plans Tuesday to buy a sizable chunk of mortgage-based securities, interest rates dropped to the mid-5 percent range and stayed there through yesterday. The move is giving borrowers a "taste of the bailout pie," said analyst Mike Larson of Weiss Research. Until now, most government mortgage initiatives have been aimed at lenders or at distressed borrowers. “

“Rates on a 30-year fixed-rate mortgage dropped a quarter of a percentage point from Monday to 5.76 percent yesterday -- the lowest since early February, according to research firm HSH Associates.”

“Lenders said most inquiries came from clients eager to refinance because they were angst-ridden about the economy or their jobs and wanted to get any savings they could find. When interest rates drop, the first borrowers to take advantage tend to be refinancers, because there's little hassle or downside.”

“However, whether those refinancers will actually get this week's rates remains to be seen.” <Source>

But is this pattern of quantitative easing working? It is just too early to tell.

Unfortunately, this news story is reporting anecdotal evidence of a favorable change which may or may not be reflected in the real mortgage refinancing numbers which are typically made available a month or so after the end of the target month.

What can YOU do?

For those who are trying to refinance properties, keep track of the sales of similar homes in your immediate area to insure that an appraiser’s “comps” represent truly equivalent properties. Be ready to argue with appraisers who use bank “short sales” or other seller-contribution tricks which allows buyers to report lower home prices.

Trust but verify!

Keep track of credit card lines and HELOCs. Do not close any card which has a zero balance as the card’s limit boosts the amount of “available credit” and thus your credit scores. If a card issuer has reduced your credit line, make sure that you reduce the balance on that card – especially if the card is one of your higher interest cards. Always ask for a lower rate and/or higher balance. It can’t hurt and they definitely want to keep good customers.

Be careful of mortgage originators who are offering great rates only to renege at the closing table by presenting you with a higher rate on a “take it or leave it basis.” Try for zero cost rate locks whenever possible.

Be prepared to walk away from the deal if the rate has substantially changed or the originator has included “junk fees” which, contrary to public opinion, can be either eliminated or negotiated.

Do not make assumptions about the future market if you are not skilled in market finance. Take a good deal when it is made available. Remember, under the old scheme of things, it took a rate change of at least two points or the passage of a few years to reach a break-even on excessive origination fees.

Do not trust real estate agents who do not sign a form that they are acting in a fiduciary capacity to protect your interests. Most real estate agents are about the deal, collecting commissions – and care little or nothing for your personal welfare as there is evidence that most people do not use the same real estate agent twice.

Do not trust short term media announcements from the government, especially agencies with the motivation to report managed results which will be corrected in later media releases.

Most importantly, realize that both gains and losses are not booked until you complete the transaction. You may be much richer or poorer on paper than you are in actuality.

Be safe and be well. And, in the words of my best friend Al, this too shall pass.

-- steve

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Reference Links:

Yield on 10-year Treasury debt below 3%|Financial Times 

As Loan Rates Fall, Borrowers Seek 'Taste of the Bailout Pie:’ Consumers Flock to Cheaper Mortgages After Federal Action|Washington Post

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