The Federal Reserve Intervenes
The global markets have been in a freefall. While U.S. markets were closed for Martin Luther King Day, stock indexes from Hong Kong to London were collapsing on fears of a bond insurance market meltdown.
Then on January 22, the Federal Reserve took emergency action, slashing interest rates by 75 basis points. That was the single-largest interest rate cut going all the way back to 1984, and the first inter-meeting cut since right after 9/11. It kept U.S. markets from plunging into the abyss, but they still finished lower. And the very next day the Dow tanked 326 points before lunch. But the market suddenly reversed course. The Dow actually closed up nearly 300 points, capping a wild 5 percent intraday swing. All this happened because news leaked about more possible federal intervention in the mortgage market and a potential rescue package for the bond insurers.
More specifically:
Connecticut Senator Christopher Dodd floated the idea of creating a "Federal Homeownership Preservation Corp.," which would buy the most troubled mortgages out there and offer new loans with lower balances to the borrowers stuck with them. Those new loans would be backed by Fannie Mae and Freddie Mac, or insured by the Federal Housing Administration.
The corporation would be capitalized with $10 billion to $20 billion and its goal would be preventing more foreclosures. If the idea of the government stepping in and buying up crummy assets sounds familiar, that's because it's a tried-and-true response to financial panic.
During the S&L crisis, for example, the government set up a company called the Resolution Trust Corporation. The RTC bought up distressed assets from failing thrifts and tried to sell them over time, using the recovered money to reimburse depositors and other creditors of the failed institutions.
Meanwhile, New York insurance superintendent, Eric Dinallo, reportedly sat down with bank executives and urged them to help bail out the bond insurers. According to the Financial Times:
"The largest U.S. banks are under pressure from New York State insurance regulators to provide as much as $15 billion in fresh capital to support struggling bond insurers, people familiar with the matter said.
"Eric Dinallo, New York insurance superintendent, has met executives at the banks and has strongly urged them to provide $5 billion in immediate capital to support the bond insurers, the largest of which are MBIA and Ambac, and to ultimately commit up to $15bn."
On Thursday, January 24, it was found out that more government and quasi-governmental intervention in the mortgage markets is coming. The economic stimulus package includes a provision that would temporarily raise the jumbo loan limit, which caps the size of home mortgages that Fannie Mae and Freddie Mac can buy. The current cap is $417,000. If the Senate and White House sign off on the plan, the cap will climb to as much as $625,000 in certain higher-cost markets for one year. The proposed package will also boost the size of mortgages that the Federal Housing Administration, or FHA, can insure.
"Both moves are aimed at lowering borrowing costs for mortgage hunters who don't qualify for conventional financing," Mr. Larson states.
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About Mike Larson and Money and Markets
Mike Larson joined the company in 2001, and has more than 10 years of experience researching and writing about personal finance, investing, and the housing and mortgage industry. In 2003, Mr. Larson was named associate editor of the company's monthly Safe Money Report. In this role, he is responsible for writing and editing as well as analyzing trading opportunities for clients. Mr. Larson is also a regular contributor to the company's daily e-letter, Money and Markets.
Before joining Weiss Research, Mr. Larson was a personal finance reporter for Bankrate.com, where he wrote extensively on mortgage lending, banking, residential real estate, and Federal Reserve Board policy. His responsibilities included analyzing economic data and interest rate trends for a weekly column and developing rate forecasts for a regular index feature. Previously, Mr. Larson held positions at Bloomberg News and the Boston Herald.
Recognized as an interest rate and mortgage market expert, Mr. Larson's views have been quoted in the Washington Post, Chicago Tribune, Dow Jones Newswires, Reuters, Sun-Sentinel and the Palm Beach Post. He has also appeared as an investment expert to discuss the housing market on CNBC, CNN, and Bloomberg Television. His writing has been acknowledged by both the National Association of Real Estate Editors and the Massachusetts Press Association.
Among the first analysts to call the housing slide, Mr. Larson's new policy paper, "How Federal Regulators, Lenders and Wall Street Created America's Housing Crisis: Nine Proposals for a Long-Term Recovery" has received broad media coverage following its July 2007 submission to the Federal Reserve and FDIC.
Mr. Larson holds B.A. and B.S. degrees from Boston University.
Money and Markets (www.moneyandmarkets.com) is a free daily investment newsletter from Dr. Martin Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Weiss Research, Inc. is located in Jupiter, Florida. For more information about our editors, or to set up an interview, please contact Jennifer Moran at 561-627-3300 or visit www.moneyandmarkets.com.
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