December 9, 2007

Interest rates going down?

Barron's and PIMCO's Gross provide commentary about the diverging direction between the falling Fed fund rate and the still elevated borrowing rate for the masses. The thesis that confidence has disappeared between lenders and borrowers. Gross discuss the non impact of the Fed rate cuts:

...all bonds are viewed with suspicion. Even Agencies, the step-sisters to Cinderella Treasuries, have been avoided due to billion dollar write-offs at Freddie and FNMA. Swaps—in third place on the quality ladder, yet still reflective of LIBOR yield levels offered by the world’s best banks—provide 70+ basis point premiums or more to Treasuries across almost the entire yield curve. Agency-guaranteed mortgages, reflecting higher levels of assumed volatility, present 150 to 175 basis point pick-ups. What appear then, to be strikingly low yield levels for U.S. Treasuries, are not being reflected by the rest of the U.S. high-quality bond market. Fed ease has lowered Treasury yields, but for the rest of the market—the segment that influences the bottom line of U.S. corporations, homeowners, and consumers—not much has changed.

The main driving factor for the mushrooming credit was the influx of investments into CDO and SIVs and once that disappeared, credit markets seized. Barron's editorial :

The cheap money that fueled the housing bubble came not from banks, but from investors who bought debt backed by subprime and jumbo mortgages. The huge wave of ratings downgrades and the spike in delinquency rates has sent those investors running for the hills. And we'd bet they're not coming back just because the Fed's about to lower the funds rate. The fed-funds rate, which stood at 5.25% on June 28, is expected to be cut this week by a quarter-point, to 4.25%. Over that same time, the yield on conforming mortgages has come down to 5.59% from 6.29%, according to James Bianco, president of Bianco Research. That's because investors are willing to buy securitized, conforming mortgages that have the blessing of Fannie Mae and Freddie Mac.

Anything without the government's implicit support continues to be shunned. The yield on a jumbo loan remains at 6.5%, largely unchanged from where it stood in June. Home-equity loans cost 8.05%, up from 7.69% in June. Likewise, the yield on one-year adjustable-rate mortgages has risen to 5.63%, up from 5.5% on June 28.

So it appears that the standard rate cuts, subprime bailout plan that does not address the substance of the problem and a Super SIV fund that shuffles the problem around, are not really going to cut it. It is better to let the market forces address and deal with the issue even though the short term might have been bad but it would have been much better than the prolonging the situation and the statuesque for the long term.

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