Category: Federal Reserve


The Federal Reserve‘s plan to reinvest principal payments on some bonds into mortgage-backed securities is already contributing to the nation’s record low mortgage interest rates, Bankrate said Thursday.

Bankrate said the Federal Open Market Committee seems to be taking direct aim at mortgage rates by shifting $400 billion from short-term holdings into long-term government bonds. The program, which begins Oct. 3 and runs through June, will involve longer-term Treasury securities with remaining maturities of six years to 30 years, and will be financed through the sale of shorter-term Treasurys with maturities of three years or less.

"This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative," the FOMC said in a statement following its two-day meeting.

Analysts also said anemic economic growth and European debt fears are keeping investors on the sidelines.

Rates are unlikely to increase until mortgage refinancing and purchasing activity picks up, Bankrate said.

"In order to get the most economic impact out of low mortgage rates, the pool of prospective refinancers needs to be expanded. Deeply upside-down homeowners, those with second liens or mortgage insurance, and lender concerns about buyback liability are all formidable impediments to refinancing," according to the firm, which aggregates rate data from across the country.

The Freddie Mac primary mortgage market survey showed the average rate for a 30-year, fixed-rate mortgage remained unchanged this week at 4.09%, while the 15-year, fixed rate dropped one basis point to a new record low of 3.29%.

Meanwhile, the five-year, Treasury-indexed hybrid adjustable-rate mortgage averaged 3.02%, up from 2.99% last week and down from 3.54% a year ago.

The one-year, Treasury-indexed ARM averaged 2.82% this week, up from 2.81% a week earlier and down from 3.46% last year.

"A sluggish economy and investor concerns over the European debt markets left mortgage rates largely unchanged this week," said Frank Nothaft, vice president and chief economist for Freddie Mac.

"Manufacturing activity in both the New York and Philadelphia regions contracted in September," he said. "Moreover, the Federal Reserve board reported that households lost nearly $150 billion in net worth in the second quarter, representing the first quarterly decline in a year."

Bankrate data show the 30-year FRM at record lows for the fifth consecutive week. The average rate for a traditional mortgage fell to 4.29%, from 4.32% last week, while the 15-year FRM declined to 3.42% from 3.44%.

In addition, the 5/1 ARM decreased to 3.05% from 3.07% last week.

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The New York Times

Even though the financial markets have been counting on the Federal Reserve to take action, Republican Congressional leadership sent a letter to the Federal Reserve chairman on Tuesday evening urging it not to engage in further stimulus.

The letter was sent in the midst of a two-day meeting in which Fed officials are widely expected to undertake policies to lower long-term interest rates. That move would be intended to loosen up credit in hopes of promoting growth. The meeting ends Wednesday, and the Fed is expected to release a statement Wednesday at 2:15 p.m.

“We have serious concerns that further intervention by the Federal Reserve could exacerbate current problems or further harm the U.S. economy,” said the letter, signed by four of the top Republicans in Congress: Mitch McConnell of Kentucky, the Senate Republican leader; Jon Kyl of Arizona, the Senate Republican whip; House Speaker John Boehner of Ohio and House Majority Leader Eric Cantor of Virginia.

The Fed’s chairman, Ben S. Bernanke, has not said further stimulus was in the works, but economists and analysts have repeatedly asserted that they believe the central bank will announce more easing.

“I just don’t think the Fed will sit idly as momentum fizzles in this recovery,” said Dana Saporta, a United States economist at Credit Suisse.

Minutes from the Fed’s latest meeting revealed sharp dissent within the group of policy makers, so further stimulus is not necessarily a sure bet.

As the Republican letter notes, economists are divided on how much the move would help the stalled recovery. The Fed, after all, has tried several rounds of monetary stimulus in the last four years.

Republican Congressional leaders expressed not only skepticism that further easing would improve the recovery, but also concerns that such actions might be damaging.

“Such steps may erode the already weakened U.S. dollar or promote more borrowing by overleveraged consumers,” the letter from Republicans said.

Many economists, however, are unconvinced by these risks and argue that a weakened dollar would be good for the country because it would make American exports more attractive.

With unemployment at 9.1 percent and Congress unable to agree on fiscal policies that might encourage job creation, many advisers have been calling on the Fed to continue using whatever ammunition it has left.

The Federal Reserve is an independent body whose decisions do not have to be ratified by the president or Congress, and efforts to influence monetary policy are discouraged to maintain its credibility.

“Even if I agreed” with the Republican letter, Tony Fratto, a former adviser to President George W. Bush, wrote in a Twitter post, “I’d still disagree with the effort to put public political pressure on Bernanke.”

Over the years, there have been many efforts by members of both parties, from both the White House and Congress, to influence Fed policies, according to Allan H. Meltzer, a political economy historian at Carnegie Mellon.

Less than a year ago Michele Bachmann, a Minnesota congresswoman who is running as a Republican presidential candidate, sent a letter to Mr. Bernanke urging him to refrain from the last round of stimulus, which the Fed ultimately decided to do.

In recent months other Republican presidential candidates have stepped up their attacks on Fed policy, with Rick Perry, the governor of Texas, calling further easing “treasonous.”

Fed critics have said they are merely trying to counter pressure from Democrats for the Fed to do more.

“This is the most politicized Fed we’ve ever had,” Mr. Meltzer said. “They’ve been doing the Treasury’s work for quite some time, buying things like Treasuries and bonds. It’s no surprise that there’s political pressure coming from the other direction.”

The Federal Reserve was meant to be independent so that it would be shielded from short-term political interests, and Fed officials have repeatedly said they are unmoved by external political pressures. A Fed spokeswoman acknowledged receiving the letter on Tuesday evening but she declined to comment further.

Appearing to cave to political interests — on the left or the right — could compromise the Fed’s authority and jolt markets even more than a popular or unpopular policy decision.

If anything, Federal Reserve members seem to be trying show their ability to exert their own influence. Traditionally, Fed officials have refrained from commenting on fiscal policy except in the vaguest of terms, but in an August speech Mr. Bernanke called on Congress to avoid steep spending cuts in the near future. He also gave specific recommendations for fiscal measures to promote long-term growth.

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The New York Times

Investors have concluded that the Federal Reserve will announce new measures to promote economic growth after a meeting of its policy-making committee ends Wednesday. Long-term interest rates have moved as if the Fed had already spoken.

The central bank is often described as facing the choice of whether to do more to improve the economy. But the anticipatory behavior of investors means the Fed really faces a slightly different choice, one it has confronted often in recent years: whether to risk doing less than expected.

The overriding argument for action is the persistent weakness of the American economy, which has left more than 25 million Americans unable to find full-time work.

The Federal Reserve chairman, Ben S. Bernanke, who has made a series of unusual efforts to revive growth, has not discouraged speculation that he is ready to try again.

“I think the Fed has no choice but to act,” said Krishna Memani, director of fixed income at Oppenheimer Funds. “If the Fed were not to do anything having built market expectations to a pretty decent level, I think the markets would react quite negatively to that.”

But the Fed also faces mounting pressure against additional action, including strident criticism from Republican presidential candidates and divisions in the policy-making committee. Moreover, the options available to the central bank have less power to generate growth, a greater chance of negative consequences, or both, than those it has already tried.

Some close watchers of the central bank say investors’ behavior could let the Fed offer a token gesture now, postponing any larger move at least until its next meeting in November. After all, the Fed is reaping the benefits of action without the costs.

“There is no reason for the Fed to rush,” Lou Crandall, chief economist at Wrightson/ICAP, wrote in a recent note to clients predicting such an outcome. “It is in the Fed’s interest to milk the anticipation effect as long as possible.”

The move markets are anticipating is a new effort to reduce long-term interest rates, which would allow businesses and consumers to borrow more cheaply. Yields on the benchmark 10-year Treasury note fell to a record low of 1.88 percent at the start of last week, reflecting the Fed’s earlier efforts to lower rates and investors’ pessimism about the economy.

The hope is that an additional reduction in rates will provide a little more encouragement for companies to build factories and hire workers and for consumers to buy cars and dishwashers.

The Fed has held short-term rates near zero since December 2008, by increasing the supply of money.

To further reduce long-term rates, the Fed bought more than $2 trillion in government debt and mortgage-backed securities, reducing the supply available to investors and thereby forcing them to pay higher prices — that is, to accept lower interest rates.

The Fed could seek to amplify that effect by adjusting the composition of its portfolio, selling short-term securities and using the proceeds to buy long-term securities, which it predicts would further reduce rates.

An analysis by the forecasting firm Macroeconomic Advisers estimated that such an effort by the Fed could raise gross domestic product by 0.4 of a percentage point over the next two years, and create about 350,000 jobs. That is comparable to estimates of the impact of the central bank’s most recent aid campaign, the QE2, or quantitative easing, purchases of $600 billion in Treasury securities, which concluded in June.

Mr. Bernanke announced in August that the Federal Open Market Committee, the policy-making board, would meet for two days, extending its scheduled one-day meeting this week to include both Tuesday and Wednesday, to consider that and other options.

The Fed could take smaller steps, like promising to maintain current efforts longer. It may also consider options that could deliver a more powerful jolt to the economy, like increasing the size of its investment portfolio again. But more aggressive measures have little internal support.

The Fed, Mr. Bernanke said, is “prepared to employ these tools as appropriate to promote a stronger economic recovery in a context of price stability.”

He still commands a solid majority of his 10-member board despite the emergence of the largest bloc of internal dissent in two decades. Three members voted against the decision last month to declare an intention to hold short-term interest rates near zero for at least two more years, replacing a stated intention to maintain the policy for an “extended period.”

The central bank has also become a target of conservative politicians, with several Republican presidential candidates denouncing its efforts to increase growth. But even Mr. Bernanke’s internal critics dismiss these attacks.

“I don’t spend a lot of time worrying about what any one candidate says about us,” Richard W. Fisher, president of the Federal Reserve Bank of Dallas, told Fox Business Network in a recent interview. “The issue is to get it right.”

Of greater concern is the possibility that the Fed is nearing the limits of its powers. Interest rates are already depressed and, like a board mounted on a spring, pushing down gets harder as the floor gets closer.

Studies also have found the Fed’s success in reducing rates has not yielded the full measure of predicted benefits. Mortgages and small business loans may be cheap, but because lenders remain cautious, they are not easy to get.

The research firm Capital Economics said recently any renewed effort by the central bank would be unlikely to overcome those obstacles.

“We don’t expect it to have any dramatic impact on the wider economy because many households will still not qualify for loans at those lower rates,” it said.

The Fed also would face an increased risk of losing money on its investments.

And only so many Treasuries are available for sale. If the Fed sold all of its securities maturing in the next four years and bought only securities maturing in more than 17 years, maximizing its impact, it would end up with 70 percent of the available long-term inventory. That could interfere with the normal operations of insurance companies and other traditional buyers.

Laurence H. Meyer, a former Federal Reserve governor who now leads Macroeconomic Advisers, said he expected the Fed to conclude that the potential benefits outweighed these issues, but that it needed more time to hammer out details.

“We expect them to come out of the committee meeting feeling that they’ve decided and have a consensus to move in November,” he said.

Mr. Meyer suggested that the Fed could mollify the markets by announcing what amounts to a preview, by investing the proceeds of maturing securities — about $20 billion each month — in longer-term debt.

Such a move might not do much to move the economic needle, because the amounts involved would be minute by the standards of monetary policy, but it could be enough to preserve the valuable conviction that the Fed will do more soon.

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U.S. regulators are set to vote next week on a final rule governing the plans large banks must draft on how they can be liquidated if they are heading toward failure.

The 2010 Dodd-Frank financial oversight law requires these "living wills," which are part of the government’s new power to seize and break up large, failing firms.

The Federal Deposit Insurance Corp announced plans on Thursday for its board to vote on the final rule on Tuesday. It is drafting the rule with the Federal Reserve.

Regulators have to approve the plans once banks submit them. They can force changes to the structure of banks or other large financial companies if they believe the institution could not easily be liquidated once in trouble.

Former FDIC Chairman Sheila Bair, who left her post in July, had stressed the need for regulators to force banks to simplify their operations, such as by creating more subsidiaries, if the plans could not be easily executed.

The rule applies to banks with more than $50 billion in assets and to other large financial companies whose sudden failure could roil financial markets.

Proponents of this new power to seize and liquidate firms argue it will curb taxpayer bailouts and limit the sort of market turmoil caused by the 2008 bankruptcy of Lehman Brothers.

But analysts and market participants have expressed skepticism, saying the government would not let a large bank fail out of fear it would wreak havoc on the economy.

The banking industry raised some concerns about the earlier proposed version of the living will rule, which was released in April.

Banks such as Wells Fargo have said regulators need to do more to ensure that the plans remain confidential and not subject to disclosure through lawsuits or Freedom of Information Act requests.

Banking groups have also asked regulators to start off with a pilot program rather than subject all eligible institutions to the requirement right away.

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The U.S. economic outlook has "clearly" deteriorated this year, and the continued softness of economic indicators shows that the headwinds facing the country are even stronger than thought, Chicago Federal Reserve President Charles Evans said on Wednesday.

"Conditions still aren’t much different from an economy still in recession  ," Evans, speaking at a seminar in London said.

He said the Fed  faced significant challenges in overcoming the obstacles left behind by the financial crisis.

Evans, a voting member on the Federal Open Market Committee  , said he believed central banks should focus on medium- rather than short-term inflation as many short-term effects such as fluctuations in food and energy prices were beyond policy makers’ reach.

Given how "truly badly" the U.S. was doing on the jobs front, the Fed should consider more aggressive action, he said.

He did not explicitly call for more quantitative easing  or bond purchases but called for "strong action."

"I argue that the Fed should seriously consider actions that would add very significant amounts of policy accommodation," he said. "Such further policy accommodation does increase the risk that inflation could rise temporarily about our long-term goal of 2 percent," he said.

The Fed Open Market Committee said in August that it would continue to keep its benchmark interest rate low for at least through mid 2013, acknowledging that the recovery it had hoped for had so far failed to take shape.

The Fed ended a $600 billion Treasury bond-buying program at the end of June.

Temporary inflation above 2 percent is not something we should "regard with horror," he said.

Evans said it was "painfully obvious" that large quantities of unused resources were an enormous loss to the U.S. economy, referring to the 14 million Americans unemployed today.

Some argue there are limits to what further accommodative measures can do, he said, adding: "I’m personally much more optimistic and don’t want to subscribe to that pessimistic view."

"Monetary policy should be used more aggressively to try to increase aggregate demand," Evans said.

He added he fully supported the policies implemented by the Fed, but added that more needed to be done.

"We should not be afraid of such temporarily higher inflation results today…These are not usual times," Evans said.

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Whether the Federal Reserve likes it or not, its unprecedented monetary polices over the last few years have conditioned the financial markets to expect a helping hand when the going gets tough.

That’s why all eyes will be on Ben Bernanke, the central bank’s chairman, when he speaks Friday at the Fed’s annual symposium in Jackson Hole, Wyoming.

With the stock market mired in a month-long slump and both the U.S. and euro zone economies in danger of sliding into recession, investors are bracing for a possible repeat of last year’s performance, when Bernanke hinted the Fed would act if conditions deteriorated.

Two months later, the central bank began pumping $600 billion into the financial system through direct purchases of Treasury debt, a second round of stimulus that markets dubbed "QE2."

While the jury’s still out on how effective these purchases have been, few are ready to rule out QE3 entirely.

Wyoming may conjure up images of the American Wild West, but markets aren’t expecting Bernanke to ride into the mountain resort with guns blazing — at least not yet.

While the economy has taken a turn for the worse — growth ground to a halt in the second quarter and nearly flat-lined in the first — there’s a sense that the Fed will want to wait a bit longer to assess the impact of its past stimulus.

Other Fed policymakers have sought to downplay expectations of an imminent QE3 announcement. St. Louis Fed President James Bullard was quoted in Japan’s Nikkei newspaper saying that while the Fed could buy more bonds if the economy weakened, the time was not right for such a move.

"Going into Bernanke’s speech at Jackson Hole, people are positioned for a significant shift in policy. (But) we think financial market conditions have to deteriorate even further for more QE3," said Simon Derrick, head of currency research at Bank of New York Mellon.

Nonetheless, traders are still expecting Bernanke to signal in some shape or form that he hasn’t run out of bullets and could start shooting again if need be.

"Based on our conversations with clients, we believe investors would be very surprised if the speech did not include a discussion of asset purchases," strategists at Goldman Sachs wrote in a note to clients.

They said this could involve the Fed reinvesting proceeds from maturing assets into 10- and 30-year Treasuries to hold long-term interest rates low.

"I think we’ll see (QE3) because America needs growth, but I don’t think we’ll necessarily get it on Friday," said Neil Dwane, chief investment officer for Europe at RCM.

Current market moves reflect this. While still down about 15 percent from late July, the S&P 500 rallied smartly Tuesday and the dollar has struggled against major currencies.

More stock market gains could be in store if Bernanke gives a strong hint of future action. After Bernanke’s speech last August, the S&P 500 began a rally that took it up nearly 25 percent by May 2011.

Pulling the trigger now would have the element of surprise going for it and might spark the most aggressive market moves.

There’s been some talk in bond market circles that the 10-year yield’s dip below 2 percent reflected a pricing in of QE3, though those moves probably had more to do with recent dismal jobs, manufacturing and growth data.

Still, there are impediments to launching QE3.

For one thing, Bernanke already caught investors off guard earlier this month and slowed a market rout when the Fed pledged to keep interest rates near zero until at least 2013.

Steven Bell, director of GLC Ltd, a global macro hedge fund in London with $1 billion in assets, also noted that higher inflation may make the Fed cautious. "We have core inflation going up," he said. "It may be low but it’s still going up."

Political opposition is also on the rise. Texas Governor Rick Perry, a candidate for president, even said he would consider it "treasonous" if Bernanke "prints more money between now and the election" in 2012.

That populist anger stems partly from the fact that Fed policies have done little to increase hiring or spark a housing market recovery.

"The history is $600 billion (in bond purchases) hasn’t really made any difference to the U.S. economy," Dwane said. "It’s still where it was when he was talking about it last August: nearly in recession."

If QE3 fails to boost growth or stokes inflation, markets may wish the Fed had done nothing.

"Investors are becoming more cynical," said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "Central bankers and governments seem to playing the role of the Dutch boy trying to plug holes in the dike."

A humdrum speech that neither announces plans for QE3 or even hints at the Fed’s willingness to act is probably the most unlikely scenario, as far as markets are concerned.

If Bernanke did go that way, it could signal that the hawks were gaining the upper hand. Three Fed policymakers voted against extending the zero interest rate pledge to 2013 and have argued that the Fed cannot do much more to boost growth.

Fred Dickson, market strategist at D.A. Davidson & Co, noted that policy remains very loose even without QE3. In addition to holding rates near zero, the Fed has said it will reinvest the proceeds of maturing assets on its "extraordinarily large" $2.8 trillion balance sheet.

"So they have a stealth QE3 policy in place already," he said.

No mention of future easing would likely hurt stocks but should spark a short-term dollar rally. Treasuries would likely fall as expectations of more Fed support faded.

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New York Times

Financial regulators have taken a public thrashing for going easy on banks before the financial crisis hit, allowing institutions big and small to dole out dubious loans. Now, according to some community bankers, regulators have abandoned their light touch for a heavy hand at a time when the industry is struggling to recover.

The Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency have dispatched on-site examiners to scour banks for minuscule problems, bankers said in Congressional testimony on Tuesday. While regulators say they are trying to prevent further bank failures, bankers complain that the examinations amount to nitpicking.

“We have found the field examiners less willing to disclose conclusions and very guarded in acknowledging progress in those areas where we may have been performing well,” Chuck Copeland, the chief executive of First National Bank of Griffin, Ga., said at a House Financial Services subcommittee hearing in Newnan, Ga.

Since the crisis hit, Georgia has had 67 institutions fail, more than any other state. Community banks, those with $10 billion or less in assets, make up the bulk of those now-shuttered institutions.

For all the talk of Bank of America’s beleaguered stock price and Goldman Sachs’s disappointing earnings, small banks are faring far worse than their large Wall Street counterparts. More than 380 banks have failed since early 2008; 326 of which were community banks, according to the F.D.I.C.

“The F.D.I.C. is keenly aware of the significant hardship of bank failures on communities in Georgia and across the country,” Bret D. Edwards, the head of the agency’s division that oversees bank failures, said in prepared testimony before the financial services committee.

But some bankers say their regulators are making matters worse by misunderstanding the cause of the industry’s woes. Mounting losses at small banks are not owed to reckless risk-taking, community bankers say, but the unforeseen collapse of the commercial real estate market in the Southeast.

“Did we have a role setting ourselves up to become victims? No doubt,” said Mr. Copeland of First National Bank of Griffin, a nationally registered bank that is overseen by the Office of the Comptroller of the Currency. “But did we recklessly pursue growth and earnings at all cost with no regard to the other elements of our mission? Never.”

That message is lost on regulators, he said. “We understand that it is not a personal affront; it is simply this environment of second-guessing and weariness in which we are all operating.”

In testimony before the subcommittee, regulators said they were taking steps to address the perception that their examiners are overly strict.

“The Federal Reserve takes seriously its responsibility to address these concerns,” Kevin M. Bertsch, an associate director of the Fed told the subcommittee. The Fed, he said, has created training programs for its examiners and conducts occasional reviews of their examinations.

For its part, the F.D.I.C. said it was reaching out to bankers for guidance on the examination process. In 2009, the agency created the Advisory Committee on Community Banking, made up of small bankers from across the country, according to Mr. Edwards of the F.D.I.C.

“The F.D.I.C. takes great care to ensure national consistency in our examinations,” Mr. Edwards said.

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Washington Post

President Obama has directed a small team of advisers to develop a proposal that would keep the government playing a major role in the nation’s mortgage market, extending a federal loan subsidy for most home buyers, according to people familiar with the matter.

The decision follows the advice of his senior economic and housing advisers, who favor maintaining the government’s role as an insurer of mortgages for most borrowers. The approach could even preserve Fannie Mae and Freddie Mac, the mortgage finance giants owned by the government, although under different names and with significant new constraints, said people knowledgeable about the discussions.

A decision to preserve a major government role would mark a big milestone in the effort to craft a new housing policy from the wreckage of the mortgage meltdown and could mean a larger part for Fannie and Freddie than administration officials had signaled.

In a statement, the White House said it is premature to say that senior officials have agreed on any of the three main options outlined earlier this year in an administration white paper on reforming the housing finance system.

“It is simply false that there has been a decision to move forward with any particular option,” said Matt Vogel, a White House spokesman. “All three options remain under active consideration and we are deepening our analysis around how each would potentially be implemented.  No recommendation has been made to the president by his economic advisers.”

The proposal is likely to draw criticism from many Republicans, who blame the financial crisis on policies they say overly encouraged the housing market. And many economists, including some who have worked in the White House under Obama, consider the federal role harmful to the free market.

But if this approach became law, it probably would keep in place the kind of popular home loans that have been around for decades — 30-year fixed-rate mortgages with relatively low interest rates.

Officials have not determined whether to advance a final proposal before the 2012 presidential election. Officials from the White House, the Treasury Department and the Department of Housing and Urban Development are working out the details.

The government could maintain a substantial role in various ways. These include restructuring Fannie and Freddie as public utilities overseen by a government regulator. The government would no longer guarantee their financial health, as in the past, but would continue to backstop the mortgage-backed securities they issue using loans made by private banks.

Or the two companies could be shut down and replaced with several successors that, likewise, would have their mortgage-backed securities guaranteed by the government in exchange for a fee. A federal guarantee, by reducing the risk to investors, can make it cheaper for firms to raise money for making home loans, in turn reducing mortgage rates.

For years, Fannie and Freddie — shareholder-owned companies chartered by Congress to support the housing market — owned or insured trillions of dollars in home loans. When the housing market crashed, the government seized the firms, and it has spent more than $150 billion propping them up.

Since then, Fannie and Freddie have played a key role in ensuring the availability of mortgages amid the market upheaval. But the Obama administration has said it wants to scale back the federal role.

In weighing whether to preserve Fannie and Freddie, administration officials have several concerns, said people familiar with the discussions. They spoke on the condition of anonymity because the talks are still preliminary.

The firms spent decades developing a market in which investors worldwide can buy and sell securities backed by U.S. home loans, and administration officials don’t want to jeopardize it.

In addition, officials don’t want to punish the thousands of Fannie and Freddie employees who have specialized knowledge about the mortgage market and had nothing to do with the poor business decisions top executives made in the run-up to the financial crisis.

But some critics warn that nearly any government role could leave taxpayers on the hook.

“The long-term consequence is that the taxpayers ultimately have to bail out the government’s losses,” said Peter Wallison, a fellow at the American Enterprise Institute. He added, “There is only one legitimate role for government in guaranteeing mortgages: That is mortgages for low-income people, to enable them to buy homes.”

Under the approach Obama endorsed, the government would seek to limit the exposure of taxpayers. Fannie, Freddie or other successor firms would charge a fee to mortgage lenders and banks and use the money to create an insurance pool to cover losses on mortgage securities caused by defaults on the underlying loans. The government would be the last line of defense in case of another housing market meltdown, using taxpayer money to cover losses only if the insurance pool ran dry.

Some special advantages awarded to Fannie and Freddie would be eliminated, according to people familiar with the matter. For example, the two companies were allowed for decades to do business while holding a fraction of the reserves — essentially, rainy-day money — that banks and other financial firms were required to hold. This advantage allowed Fannie and Freddie to grow very large. The companies, or the firms that replace them, would have to start holding much more in reserve.

The administration’s strategy also would require Fannie and Freddie, if they remain in some form, to shed many of the mortgages they own. Their loan portfolios, which have ballooned recently, would shrink greatly over coming years and perhaps be eliminated. Private firms would have to fill the void.

“We remain committed to winding down Fannie and Freddie, though such significant measures would need to be done gradually and with care,” said Vogel, the White House spokesman. “We believe that it is essential to bring private capital back to the center of a reformed housing system.”

Although banks would be able to make any home loans they wanted, only those that met federal standards would be eligible to be included in securities assembled by Fannie, Freddie or successor companies. And only those securities would have a government guarantee.

Any effort to remake the nation’s housing finance system would be phased in over five to 10 years.

Since early in his tenure, Obama has promised to offer a proposal to overhaul the nation’s housing finance system.

In February, the administration released a long-awaited white paper discussing an overhaul of the housing finance system. The paper called for the end of Fannie and Freddie but did not say what should replace them.

Three options were presented. The first two called for greatly reducing the federal role in the mortgage market, perhaps eliminating it. A third option called for largely maintaining the government’s footprint but introducing several changes to reduce the chances that another taxpayer bailout would be needed. 

(All of the options preserved the Federal Housing Administration, a government agency that helps low- and middle-income and minority home buyers.)

The administration’s decision in February to release a series of options — and not make a formal recommendation — reflected a political calculation and a disagreement among Obama’s advisers.

Two top Obama advisers, HUD Secretary Shaun Donovan and Treasury Secretary Timothy F. Geithner, think the government should maintain an outsize role in the housing market, administration officials said.

Donovan thinks federal support for housing fulfills a public service, while Geithner has been focused on the need for the government to have a way to keep the mortgage market operating during a financial crisis.

Other advisers, however, opposed a continued government role over the long run. Austan Goolsbee, who this month left his job as chairman of Obama’s Council of Economic Advisers, argued that the federal role in housing distorts the free market. By subsidizing mortgage investments, he argued, the government drives capital away from other types of investments — for example, those in companies developing environmentally friendly technology. He also warned that the government is putting enormous sums of taxpayer money on the line while conveying little actual benefit to home buyers.

In a meeting with the president, Goolsbee said that the government had finally brought Fannie and Freddie’s excesses to heel by taking over the companies and that it would be a mistake to let them loose in the market again, said a person familiar with the meeting. Goolsbee likened the companies to a villain held in a special prison who shouldn’t be freed just because he promises to help the poor, the source recounted.

Lawrence H. Summers, who was director of the National Economic Council until early this year, argued that, over the long term, it didn’t make sense to have a government-backed agency providing guarantees to the mortgage market but that Fannie and Freddie still play a crucial role.

“My position was that we needed to maximize activity in the short run to support the housing market,” Summers said in an interview. “Discussions of scaling down Fannie and Freddie were vastly premature under the circumstances of a collapsing housing market.”

After a decade or so, he added, the government role might be phased out. He cautioned that models similar to Fannie and Freddie “were problematic because they were likely to lead to the same type of abuses” that Fannie and Freddie engendered.

Gene Sperling, who became director of the National Economic Council this year, shepherded the release of the white paper. He agreed that a continued government guarantee made sense.

In the end, Obama signaled agreement. The White House, however, says the president has not made a final decision.

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The Federal Reserve is considering renewed efforts to boost growth should the weak U.S. economic recovery and high unemployment take a turn for the worse.

Even though employers added a surprisingly hefty 117,000 jobs in July and the jobless rate slipped a tenth of a percentage point, no one argues the job market is robust. Officials will remain vigilant for signs subpar growth is entrenched or is at risk of petering out altogether.

The possibility that financial market strains from the ongoing debt crisis in Europe and jitters following Standard & Poor’s downgrade of U.S. debt boost chances the Fed may consider actions to buttress recovery.

The Fed has already mounted one of the most aggressive central bank easy money campaigns in history: it cut interest rates to near zero in December 2008 and has since bought $2.3 trillion in assets to provide an additional prod to economic activity.

Yet officials maintain the Fed still has arrows in its quiver — should conditions warrant firing them.


* It could return what appears to have been its most potent conventional tool, another round of large-scale asset purchases.

* It could make a smaller move, such as deliberately restocking its balance sheet to emphasize longer maturities, pushing down longer-term interest rates.

* Cement commitments to low rates and easy money in ways that might free up buying, building and hiring. One such initiative might be to bolster its promise to maintain rates low for an extended period; a second might be to promise to keep its much-expanded balance sheet large for an extended period.

Most analysts believe a communications measure or rebalancing of the Fed’s portfolio is the most likely first step and that more bond buying would only occur if conditions worsened significantly.

* Setting explicit targets for inflation or price levels. A firm inflation target would strengthen confidence that the Fed won’t let inflation get out of hand; a price level target would give the Fed more leeway to spur growth while keeping inflation in check.

* The Fed could lower the interest rate it pays banks on excess reserves, forcing banks to lend the money to obtain higher rates of return.


* Inflation worries: after the Fed’s $600 billion second round of quantitative easing, or QE2 as it became known, commodity and energy prices soared worldwide. The Fed was blamed for fueling inflation although Chairman Ben Bernanke and other economists argued rising demand around the world was the principal cause of rising prices.

Even so, U.S. inflation is now near the Fed’s preferred level of 2 percent or a bit below, depending on the gauge. When the Fed launched QE2, inflation was near record lows.

Bernanke has said that higher U.S. inflation is one restraint on Fed willingness to ease policy.

* Political pressures: the Fed was savaged at home as well as abroad for QE2. U.S. lawmakers took the Fed to task for risking inflation and proposed narrowing its mandate to focus only on price stability, not on growth.

While the central bank has over the years established a reputation for political independence, the risk of stoking further anti-Fed sentiment on Capitol Hill could give policymakers pause.

* Effectiveness questions: although a study by Fed economists said large-scale asset programs lowered rates on 10-year Treasury bills by between .30 of a percentage point and 1 percentage point, impact is a subject of heated debate.

Detractors point to the continued struggles of the economy — which grew at less than a 1 percent annualized rate in the first half of the year — as signs of quantitative easing’s limitations. Supporters counter that without the bond buying, things would have been worse.

* Policy fatigue: after Fed purchases of near $1.4 trillion worth of mortgage-related debt and $900 billion of Treasury securities, many wonder whether additional bond buying would have diminished effect.

Furthermore, some Fed officials believe that despite stumbles, the recovery is on track and that the Fed’s next step should be tightening, not further easing.

* Difficult exit: critics worry that when the recovery begins to gain traction, the Fed will have difficulty shrinking its balance sheet from its current $2.9 trillion size, let alone a larger one. Failure to reverse easy money policies in time could ignite inflation and plunge the economy into a fresh crisis.

Fed officials say they have the tools in place to tighten monetary policy even with a bloated balance sheet. However the reversal of quantitative easing on such a large scale has never been undertaken before.


* Quick response: although the Fed was criticized for being slow to react initially to the financial meltdown that began in mid-2007, Fed Chair Bernanke’s track record reflects a willingness to take bold steps quickly in response to deteriorating conditions.

* Emphasize growth: even a smaller step such as a commitment to maintaining a large balance sheet would signal to markets that the Fed sees weak growth, and not rising inflation, as the main risk to the recovery, but would do so without the potentially controversial step of committing to another sequence of bond buying.

* Encourage risk-taking: moving to longer maturities could push down interest rates for longer-dated securities and push investors to take on riskier assets, such as stocks.

* Lower interest rates: by weighting the Fed’s portfolio to longer-dated maturities, buying more bonds, the Fed would be pushing down longer term rates even more, thus encouraging borrowing and hopefully, spending, investing, and hiring.

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property tax appeal


The U.S. Federal Reserve managed to spark a stock rally on Tuesday, but some economists are now left wondering if it will take tax cuts to inject real life into the broader US economy.

The Fed  told investors it will keep rates at zero until 2013, and said it would consider further moves to boost growth. Following the news, stocks on Wall Street surged higher and ended the session up more than 4 percent, helping to erase some of the losses made over the last 7 days.

Despite the rally, the Fed’s statement did not reflect well on the health of the economy. Growth is weaker than expected, and unemployment is set to remain stubbornly high. The fact that the Fed will keep rates at zero for another two years is hardly a vote of confidence.

So what to do? Among many economists, there remain big doubts over the effectiveness of further quantitative easing (QE) .

“QE pumps money into the system and helps the economy via the wealth effect, but you need something to push demand,” Hans Redeker, the global head of foreign exchange strategy at Morgan Stanley, told CNBC on Wednesday.

Demand was underpinned by fiscal policy after the 2008 financial crisis, but Redeker said that government debt in the US and Europe have removed fiscal policy as a viable option now.

Ian Shepherdson, chief US economist at High Frequency Economics, sees no way that governments will be able to spend their way out of broad economic malaise.

“On the fiscal front, it is clear that the chance of stimulus via government spending is nil,” Shepherdson said.

“But on the other side of the accounts, things are different," he said. "We wonder if President Obama might be bold enough to propose that taxes be cut substantially for a while. It seems to us that Mr. Obama has a prime opportunity to call the Republicans’ bluff,” Shepherdson said.

“They say they want tax cuts, Republicans exist to cut taxes, so why not offer them tax cuts and dare the GOP to vote against them?” he asked.

Redeker does not agree that tax cuts would be the only option on the table to boost demand, but thinks instead that the answer lies with the G20.

“The G7 is not going to boost demand via fiscal policy. The only countries that can are China" and elsewhere in Asia, said Redeker, who believes a deal could be in the cards in which the U.S. rules out further QE in return for China and others to use their fiscal muscle to boost global demand.

The big effect from the Fed’s statement was on the bond market, according to Dennis Gartman, the Founder of The Gartman Letter. He told CNBC that Bernanke had effectively restructured the bond market, making 2-year paper into an overnight lending facility with very low yields  .

“He made the world say I might as well own Johnson & Johnson [JNJ 60.17 -2.03 (-3.26%) ], as the yields in the bond market are so low,” Gartman told CNBC.

Seeing nothing that would point to a prolonged appetite for risk among investors, Redeker said the Fed meeting had at least turned around the conversation.

“A few weeks ago if you got weak data, it meant ‘risk off.’ Following the last few days, if we get weak data, it will be ‘risk on’ as we get closer to a tipping point on QE3,” Redeker said.

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