Expectations that the Federal Reserve will cut the federal funds rate this year rose Tuesday after Sen. Chris Dodd said Fed Chairman Ben Bernanke is “prepared to use all the available tools at his disposal” to keep money flowing to mortgage lenders.
The Bush administration, however, remains opposed to lifting caps on Fannie Mae and Freddie Mac’s lending portfolios.
Dodd, the Connecticut Democrat who chairs the Senate Banking Committee, said he did not specifically ask for a cut in the federal funds rate — the rate banks charge each other to loan overnight — during a meeting Tuesday with Bernanke and Treasury Secretary Henry Paulson.
To do so would create the impression he was putting political pressure on an independent agency, Dodd said after the meeting. The presidential hopeful said the issues he raised with Bernanke and Paulson included lifting caps on Freddie Mac and Fannie Mae’s lending portfolios, encouraging lenders to use the Fed’s discount window, banning predatory lending practices, and reforming the Federal Housing Agency.
Dodd said Bernanke told him he was “absolutely” prepared to use all the tools available to him. Although Dodd did not raise the issue of the federal funds rate, he said it has historically tracked movements of the discount rate, which the Fed shaved by 50 basis points on Friday to 5.75 percent.
The discount rate is the rate banks in the Federal Reserve system charge to lend money directly to banks. Although banks don’t like to borrow money through the “discount window,” the Fed will accept mortgages as collateral for such loans, and is encouraging lenders to use it by allowing loans of up to 30 days, instead of just overnight.
By slashing the discount rate and injecting more than $100 billion into financial markets in the last week, the Fed hopes to reduce the impacts of a liquidity shortage that has required some mortgage lenders to cut back on or stop making loans.
But many financial market players are still hoping the Fed will cut the federal funds rate, which has stood at 5.25 percent since the summer of 2006, when the Federal Reserve’s Open Market Committee completed a string of 17 consecutive increases in the rate to keep inflation in check.
The National Association of Realtors is now factoring into its projections an assumption that the Fed will cut the federal funds rate by 50 basis points this year, starting with a 25-basis-point reduction in October, said NAR economist Kevin Thorpe.
The federal funds rate is not directly correlated to mortgage rates, Thorpe said, but NAR expects a federal funds rate cut would have a positive impact on housing markets.
“We believe there is pent-up demand in the marketplace right now,” Thorpe said. Adding liquidity to the marketplace would make it easier for prime and subprime borrowers to get a loan, Thorpe said, and “that should help demand translate into home sales.”
By providing liquidity, a reduction in the federal funds rate could also help troubled borrowers avoid foreclosure by refinancing out of adjustable-rate mortgages, Thorpe said, and reduce the rates on conventional 30-year mortgages “by sending a signal to the marketplace that the Fed is less concerned about inflation.”
Thorpe said NAR is projecting home sales to improve in the fourth quarter, “and we really see it picking up in the first part of 2008.”
Although Dodd said he was encouraged by Bernanke’s stance during Tuesday’s meeting, Paulson gave no indication that the Bush administration is ready to lift the $1.4 trillion cap on Fannie and Freddie’s loan portfolios, as some lawmakers have urged.
“I left here with the sense that the Fed gets it and understands it,” Dodd said at a news conference following the meeting. “I’m still concerned that Treasury does not appreciate the importance” of the problems in mortgage lending and their effect on the housing downturn.
The Bush administration has maintained that raising the caps — imposed in the wake of management and accounting scandals at Fannie and Freddie — would do little to improve liquidity in the secondary markets for subprime and Alt-A mortgage loans. That’s because most of the loans Fannie and Freddie repurchased and guarantee are prime, conventional conforming loans, which remain available to those with good credit.
Paulson restated that position in a television interview after his meeting with Dodd, saying lifting the caps “doesn’t do much of anything” to relieve the liquidity shortage.
