CMG quoted in the NYSun. 2.15.08

Mortgages Get More Costly As Fed Cuts Interest Rates
By JULIE SATOWStaff Reporter of the SunFebruary 15, 2008

Since the Federal Reserve chairman initiated a series of aggressive interest rate cuts last month, it has actually gotten more expensive for buyers to take out mortgages.

The reason is that investors are increasingly fearing inflation and are driving up the yield on the 10-year Treasury, off of which most residential mortgage rates are priced. In fact, the yield on the 10-year note topped 3.8% yesterday, a one-month high; before Chairman Ben Bernanke's surprise 0.75 -percentage-point rate cut in January, the yield was 3.4%.

Bond buyers aren't likely to be reassured anytime soon, with Mr. Bernanke testifying yesterday before the Senate Banking Committee that additional rate cuts are possible. He has already cut the target for the key federal funds rate by 2.25 percentage points since September, chopping off 1.25 percentage points, to 3%, in January alone. The Federal Open Market Committee, which is responsible for cutting rates, is next scheduled to meet March 18.

"The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks," Mr. Bernanke said. He also called the economy "sluggish," saying it was unlikely to recover until later this year, and suggested there would be more mortgage-related losses at banks.

The markets responded poorly to Mr. Bernanke's testimony, with the Dow Jones industrial average falling 175.26 points, or 1.4%, to 12,376.98 at yesterday's close. The 10-year Treasury fell for the third straight day, with the yield curve steepening as the 10-year yield reached its highest level compared with the two-year Treasury yield since July 2004.

"The bond market has the ability to see into the future, and the smart money sees inflation out there," a principal at mortgage firm Commodore Mortgage Group, Richard Bouchner, said. He said that when rates were lower, he called all of his clients suggesting they refinance their mortgages. "Most stayed on the sideline because they expected more rate cuts, but now they've missed their opportunity," he said.

Mr. Bernanke's rate cuts haven't just failed to lower mortgage rates — the Fed chairman is also spurring a new credit crunch, analysts say. The leverage loan market is nearly closed, with yields so low that they offer little incentive for lenders, while worries over defaults persist.
"With Mr. Bernanke's reiteration of his current rate-cutting path, the credit market noose continues to tighten," an equity strategist at Miller Tabak + Co., Peter Boockvar, wrote in a research note. He called the tightening of credit in the market "an unintended consequence" of the Fed's rate cuts.

In addition to a lack of leveraged loans, there is a shutdown of so-called auction rate securities. This is a more than $300 billion market where long-term municipal bonds, student loans, and corporate bonds are repackaged to create short-term paper and auctioned off to investors. Investors, however, have stopped bidding for them, and so banks have stopped providing auction support. Investors and banks are balking because the breakdown in bond insurance for these securities, as monoline insurers such as MBIA and Ambac struggle to cover their losses, as well as the low yields, provide little incentive for investors to take on the growing default risk.
An analyst at Banc of America Securities, Jeffrey Rosenberg, wrote in a research note on Wednesday that 80% of these auction rate securities auctions are failing.

"With a total size of $330 billion and roughly half of that held by individuals, a significant, albeit likely short lived liquidity crunch is again emanating out of the credit markets," he wrote.
Not everyone believes Mr. Bernanke's rate cuts are bad for the economy. "The rate cuts are definitely helping," a professor of economics at New York University, Mark Gertler, said. Mr. Gertler attributed rising yields on the 10-year Treasury note to investors predicting the economy will improve and that the Fed will eventually raise rates again. "It's going to be a sluggish period for a couple of quarters, but I have reason to believe we will be in a recovery by the end of the year."

Still, a growing number of investment banks and economists are predicting we are in a recession, and some feel that Mr. Bernanke's rate cuts are not addressing the problems.
"Unfortunately, bankers are no longer in the business of taking deposits and loaning money, but rather in securitizing loans," a professor at the University of Maryland School of Business, Peter Morici, a former chief economist at the International Trade Commission, said. "Mr. Bernanke has simply not addressed this more fundamental structural problem that frustrates his monetary policy. Lowering the fed funds rate does absolutely nothing to help clear up that issue."