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Fed makes a First by Saying Give Us Your Mortgage-Backed Securities as Collateral to Loan Money; Sends DOW ZOOMING!
I have to give it to the Fed and Ben Bernanke. He made a major change in how the Fed operates. Many mortgage companies, banks, and investment companies are holding mortgage-backed securities that absolutely no one will buy in this turbulent real estate market. The Fed has stepped up big-time and said they will now accept these securities as collateral for treasuries that they then will lend to the institutions asking for the loans. Here’s a rundown:
- The bank or institution has a lot of mortgage back securities, which are bundled-up packages of loans on individual mortgages. The bank or institution needs some cash to operate or build their business, but since they are unable to sell the mortgage-backed securities to anyone, they have to sit and wait for the market to loosen up. But it’s not happening! A good comparison would be an individual who needs cash and wants to sell his classic car to raise money for something, but everyone has decided classic cars are not in style and will not buy it. No one will purchase the car at any price, although it is worth “something.” The individual is stuck and cannot sell his major asset or borrow against it.
- The FED now says, “Look, we’ll give you loans that were not available previously and you may use those mortgage-backed securities as collateral. You don’t pay us back! We, the Fed, will sell the assets.” It’s true that right now no one is buying them, and it’s kind of risky, but something has to be done to loosen the credit markets. Of course, they’re not lending $1 for $1. There will be a discount to ensure that the Fed is covered. It’s most likely that the Fed is lending $6 or $7 for every $10 they’re getting in collateral from the borrower. The Fed’s intention is to stimulate the economy as well as help alleviate the real estate situation engulfing most of the country, especially Arizona.
- The bank or institution now can use the money that was tied up in the mortgage-backed securities to reinvest in their businesses or whatever else is needed. This makes a HUGE DIFFERENCE!
This was huge for the markets. The DOW was up 415.36 on the day! IT WAS THE LARGEST ONE DAY ADVANCE IN WELL OVER 5 YEARS! This is after a 4-day decline, and things were starting to look bleak. There is an additional positive by-product of the Fed’s action. If this new plan is as successful as hoped, the Fed may not have to lower interest rates to help stimulate the economy, though they may in the short term. The Fed needs to keep control of interest rates in order to keep inflation under control. Furthermore, the credit crisis (pure lack of capital to lend out to businesses and individuals to make purchases) is the underlying issue with the marketplace. The Fed has come up with a perfect solution to help everyone: take in what no one will purchase due to uncertainty in the real estate market across country, and then give treasuries out to allow purchases and loans to be given out.
This is a pure stimulus to the entire marketplace, especially the real estate business, mortgage lenders and banks. Homebuilders’ stocks went up significantly; some builders were up 16% or more on the day! Financials were up significantly. AMEX (American Express) was up 8% and even long-battered Countrywide was up 16%. It’s just HUGE!
Maybe I’m just crazy, but I think this could completely help stabilize the real estate markets across the nation. Now lending institutions can get some cash out of the mortgage securities they have had to sit on with no buyers for almost 9 months. Most of these loans are designed to package and sell to pension funds and mutual funds that want a little stability for their overall holdings. And when the real estate market goes south hard and fast, no one is willing to buy, thus locking up the banks and institutions. All I can say is way to go Uncle Ben!