January 19, 2004

Why the Fed may not raise rates, part two

If the falling dollar isn't hurting the purchasing power of Americans at home, then why worry? Raising interest rates to "defend" the dollar only makes sense if the weak dollar is causing a sell-off in American financial assets or rampant inflation. And so far, neither of those things is happening. In fact, low-interest rates are the key to credit creation in the American economy. As long as long-term interest rates stay low, mortgage rates stay comparatively low. And as long as they stay low, housing sales will stay strong and so will refinancing activity. And if THAT's the case, then there is a seemingly inexhaustible demand for the bonds and mortgage-backed securities issued by Fanny Mae and Freddie Mac to fund the whole operation. The gases sell bonds to finance the purchase of mortgages from primary lenders. Who buys these bonds and why? Pension funds, banks, life insurance companies, mutual funds...industrial corporations. The bond is just as good as a Treasury, and is, in Greenspan's world, an excellent "intermediary" for hedging interest rate risk. It's also income (even though it only remains so as long as American homeowners make their mortgage payments on time.) The GSEs don't just sell bonds, though. They also pool up the mortgages they own, slap a guarantee on them, and sell a mortgage-backed security (a bond that derives its monthly payments from interest and principal payments on mortgages). Fannie and Freddie have been doing a lot of this bond issuing, mortgage buying, and mortgage-backed security issuing. They have over $3 trillion in assets. Thousands of companies own their bonds and mortgage backed securities. The Fed has little interest in shutting the whole operation down by raising interest rates. That would expose just how many companies are now dependent on the American homeowner for income...or on low interest rates and financing activity for profits. We'd find out who owns those bonds...and how many they own. Of course, to find that out, we'd probably need a regulator forcing Fannie and Freddie to disclose what they're up to. And who knows when that wil happen.... WSJ.com - Fannie Favors Treasury as Regulator: "Moving financial regulation of Fannie and Freddie to Treasury from its current location at the Department of Housing and Urban Development carries big potential benefits for the two government-chartered companies. Notably, it would strengthen investors' perception that the companies enjoy the implicit financial backing of the federal government. The downside for Fannie and Freddie is that the Treasury Department has more political clout than HUD and ultimately could prove to be tougher in reining in the companies' rapid growth, as many critics in and out of government have sought. Fannie's position doesn't remove all obstacles to legislation, however. Fannie and Freddie Mac continue to have concerns about various specifics, such as how their capital and new financial products would be regulated. This year's bill also is likely to be complicated by inclusion of the 12 Federal Home Loan Banks, which borrow money from capital markets to lend to banks for writing mortgages. Fannie and Freddie borrow to buy up the mortgages, injecting still more money into the system."


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