Fed Damages Credibility Due To “tightening of financial conditions”

While noting “improvement in economic activity and labor market conditions,” the Federal Open Market Committee voted Wednesday to continue its policy of near-zero interest rates and its $85-billion-per-month bond-buying program.

At the same time, the Fed’s own economic projections suggested the economy might not grow this year as fast as it expected just three months ago.

In a statement concluding its two-day monetary policy meeting, the FOMC said it “decided to await more evidence that progress will be sustained before adjusting the pace of its purchases.”

The Committee adopted the policy by a 9-1 vote with only Esther George, president of the Kansas City Fed, dissenting. St. Louis Fed President James Bullard, who had joined with George in her dissents earlier this year, voted in the majority as he had at the July meeting.

“The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market,” the FOMC said in its statement. “The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.”

The reference to “the tightening of financial conditions” was seen as a comment on the recent increase in mortgage rates, some of which resulted from the Fed’s own discussion of tightening its monetary policy.

The reference to “the tightening of financial conditions” was seen as a comment on the recent increase in mortgage rates, some of which resulted from the Fed’s own discussion of tightening its monetary policy.

The FOMC said its actions “should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate [of price stability and maximum sustainable economic growth].”

Fed Chairman Ben S, Bernanke had originally said the FOMC would wait until the inflation rate rose to 2 percent and the unemployment rate fell to 6.5 percent before the Fed would begin “tapering,” that is gradually tightening its stimulative monetary policy. In recent weeks though Bernanke hinted the FOMC might act before its targets were achieved. Bernanke came under criticism from some economists who suggested by acting before its own criteria were met, the FOMC would damage its credibility.

Wall Street Thrilled Over No Taper

Wall Street was more than thrilled with the Federal Open Market Committee’s decision to continue purchasing additional agency mortgage-backed securities at its current pace to foster the ongoing housing recovery and fight unemployment.

Many industry experts went to Twitter to express their thoughts on the lack of tapering:

Chandan EconomicsPresident Sam Chandan tweeted, “An insipid victory for housing markets; Fed doesn’t believe rebound can be sustained absent artificially low mortgage rates.”

“Less than 3% from Dow 16,000. No chance this momentum goes away any time soon,” tweeted Todd Schoenberger, Managing Partner and Portfolio Manager for LandColt Capital.

Wall Street Strategies CEO and Principal Analyst Charles Payne went to Twitter to say, “Fed admits failure- no tapering no tapering no tapering & down goes Frazier, down goes the $ and down goes sanity- but Wall Street thrilled!”

Corker, Warner: Long-Overdue Housing Finance Reform Within Grasp

This month marks five years since Lehman Brothers filed for bankruptcy. Many Americans can recall the shock and anxiety they felt over the next few weeks as banks of all sizes went insolvent, the stock market plunged nearly 800 points in a single day, and national housing prices sank 30%.

Yet five years later, major components of the crisis have been left completely unaddressed: Fannie Mae, Freddie Mac and our system of housing finance.

Despite being at the center of the storm and requiring a $200 billion taxpayer bailout, these two mortgage behemoths have not been reformed. The model of private gains and public losses should be eliminated once and for all.

With one proposal working its way through the House, another gaining traction in the Senate, and President Obama moving the issue to the forefront last month, we are on a trajectory to dramatically modernize the way our country’s housing finance system works. This is good news. But the stakes are high, and we must get this right.

Reform should begin with a fundamental understanding of Fannie and Freddie as government-sponsored enterprises with collective balance sheets of close to $5 trillion. At their best, the GSEs provide valuable technology, systems and legal infrastructure to connect banks in towns all across our country to global investors from London to Frankfurt to Hong Kong. At their worst, they are corporations that have historically leveraged their special relationship with the taxpayer to run thinly capitalized institutions that enriched shareholders when the economy was humming but relied on the taxpayers when the economy tanked.

Our public policy challenge is: how do we deal with twin entities that currently play an integral role in our economy but are rooted in a fundamentally flawed arrangement as semi-private, semi-public firms? Fannie and Freddie have crowded out competitors and prevented innovation in the secondary mortgage market.

Compounding this challenge, we know we must ensure a system of housing finance that isn’t prone to frequent disruption and can consistently provide sufficient credit to meet the needs of American homeowners and our multitrillion-dollar mortgage market. And we cannot accidentally tip the competitive balance in favor of the largest financial institutions – the ones that can access the global capital markets without an intermediary – while leaving community lending institutions in the dust. To these ends, we have spent the past year assessing what is worth preserving in the current system and what needs to be scrapped.

Our bipartisan bill, the Housing Finance Reform and Taxpayer Protection Act, would keep the technology and infrastructure of Fannie and Freddie, but redeploy it into an updated system where duopolies can no longer exist. In addition, capital levels for private-sector participants that take on credit risk would be substantially higher than they were in the past. We would require at least 10% capital – more than twice the amount Fannie and Freddie lost during the last crisis before there can be any taxpayer exposure.

Further, our bill would ensure that companies issuing mortgage-backed securities are legally separated from the entities that take on the risk of credit loss, so that if one firm makes bad bets and gets into trouble it can be allowed to fail without disrupting the rest of the system. And our proposed Federal Mortgage Insurance Corp. would explicitly charge for the taxpayers’ backstop risk – much like the FDIC’s operation – by assessing an up-front fee on loans that go into a government-insured mortgage-backed security. Finally, we maintain and improve existing efforts to help creditworthy Americans access homeownership, including the popular 30-year fixed mortgage. But we would completely wall off the government’s risk management and taxpayer protection roles from social initiatives and make them more accountable, transparent and subject to strict oversight.

It is past time to address this unfinished business remaining from the financial crisis. The bill we are advocating along with eight other members of the Senate Banking Committee – a strong coalition that continues to grow – can usher in a 21st-century model of housing finance that will create a dramatically better model for responsible, sustainable homeownership in this country.

China Adds U.S. Mortgage, Agency Bonds

China, the biggest foreign buyer of U.S. debt, in July bought a record amount of U.S. government agency debt and mortgage-backed securities, even as it sold Treasurys, according to data from the Treasury Department.

China’s purchases are the latest sign the country hasn’t stepped away from funding the U.S. even as prices on Treasurys and mortgage debt fell sharply this summer, sending yields higher and diluting the value of investors’ fixed-income holdings, said analysts. China was a net buyer of Treasury notes and bonds in May and June when many other investors cut back their holdings amid signs that the Federal Reserve was weighing reducing its bond purchases.

“There is no evidence that Chinese investors are losing confidence in the U.S. market,” said Ian Lyngen, a senior government bond strategist at CRT Capital Group LLC. “In fact the notion that they are buying dips [in bond prices] is longer-term constructive” for the U.S.

In July, China increased its holdings of high-grade securities sold by government-sponsored enterprises such as Fannie Mae and Freddie Mac FMCC 0.00% and securities backed by home mortgages guaranteed by the U.S. agencies, by $20.2 billion, according to the Treasury Department data on capital flows. The purchases broke the previous record of $16.9 billion in purchases in April, according to Mr. Lyngen.

Mr. Lyngen said the July amount was the biggest on a monthly basis since 1977, the earliest year the data provided by the Treasury.

While buying the U.S. agency debt, China reduced its holdings of Treasury notes and bonds by $6.48 billion in July, after a $34.7 billion net increase in the previous two months. Many investors perceive agency bonds and agency mortgage-backed securities as an attractive alternative to Treasury bonds because they are highly rated bonds and offer higher yields than Treasury debt.

Analysts continue to play down any concerns that China might dump its U.S. bondholdings, a move that could potentially expose the U.S. government to an interest-rate shock and dealing a blow to the U.S. economy.

Despite the selling in Treasury notes and bonds in July, China’s overall holdings of Treasury debt actually rose by about $1.5 billion to near a record high of $1.277 trillion thanks to its purchases of shorter-term U.S. Treasury debt called bills, which mature in a year or less.

China’s portfolio reshuffling came at a time when overseas investors were warming up to U.S. bonds again, particularly in July as the market stabilized after the spring swoon. Fed Chairman Ben Bernanke had soothed investors’ worries about rising yields that month by suggesting that there was no “preset course” for the U.S. central bank to wind down its bond-buying program.

The benchmark 10-year Treasury note’s yield hit a 23-month peak of 2.756% on July 8 and fell to 2.58% at the end of July. Bond prices rise when their yields fall.

Overall in July, foreign investors increased their holdings of long-term U.S. assets by $31.1 billion following a decline of $67 billion in June, according to data Tuesday from the Treasury.