Fed Moves to Curb Risk of Recession

Central Bank Lowers
Target Rate by Half Point,
Open to Further Cuts

By GREG IP
January 31, 2008; Wall Street Journal

Seeking to nip an incipient recession in the bud, the Federal Reserve cut interest rates for the second time in nine days, in one of its most aggressive campaigns in decades to boost the nation's economy.

The Fed lowered its target for short-term interest rates by 0.5 percentage point to 3% yesterday, and left the door open to further cuts.

In its statement accompanying the move, the Fed said "downside risks to growth remain," and that the central bank would "act in a timely manner as needed to address those risks." Investors widely expect the Fed to lower its benchmark rate again in March by 0.25 percentage point to 2.75%

Yesterday's rate cut comes as the latest news suggests the economy continues to skirt recession despite a steep slump in housing and the continuing credit crunch, but financial markets remain fragile.

Stocks rose on news of the cut, which some investors had expected to be smaller, but the market tumbled late in the day after a downgrade of Financial Guaranty Insurance Co. by Fitch Ratings intensified worries about the credit ratings of bond insurers, which insure about $2.4 trillion of debt. Such downgrades could leave banks exposed to additional losses on the mortgage-backed debt they hold, further eroding their capital and limiting their ability to lend.

The Dow Jones Industrial Average, up as much as 201 points after the Fed announcement, ended the day down 37.47 points at 12442.83.

Trimming Inventories

The government reported yesterday that the economy grew at a slower-than-expected 0.6% annual rate in the fourth quarter of 2007. Most of the weakness stemmed from companies trimming inventories, which makes future production cuts less likely. Consumer spending slowed, though to a still-respectable pace.

A private payroll survey also found employment jumped in January. That led some economists to expect the Labor Department tomorrow to report robust job growth for the month, after a slump in December.

Last week, on the heels of a global stock selloff, the Fed made a surprise 0.75-percentage-point cut in its target for the federal-funds rate, charged on overnight loans between banks. That it went ahead with yesterday's rate cut despite some encouraging economic data underlines its worries that slumping housing prices and associated losses on mortgages could yet drag the entire economy down. The Fed's 2.25 percentage points in rate reductions since September roughly equal the initial pace of cuts in early 2001 -- following the bursting of the tech bubble -- as the most rapid in two decades.

The big question now facing the Fed is whether it has done enough. Officials yesterday signaled continuing concerns about growth.

"Financial markets remain under considerable stress, and credit has tightened further for some businesses and households," the Fed said in its statement. "Recent information indicates a deepening of the housing contraction as well as some softening in labor markets," it added, echoing previous comments. But yesterday's statement also dialed back the sense of urgency, dropping the "appreciable" from what it said last Tuesday were "appreciable downside risks to growth."

The latest statement included a reminder of how much the Fed has done to date: "Today's policy action, combined with those taken earlier, should help to promote moderate growth over time and to mitigate the risks to economic activity."

Some analysts took that to mean the Fed doesn't expect to cut rates as low as 2.25%, as markets currently anticipate. "While the Fed certainly left the door open for further action, the policy assessment did seem to tilt toward reining in expectations of significant additional action," Morgan Stanley economist Dave Greenlaw said in a note to clients.

But Tom Gallagher, an analyst at brokerage ISI Group, said, "You can't be confident the Fed is done until you feel the market has a good handle on the extent of the financial crisis," which it clearly hasn't yet.

Delicate Challenge

Fed Chairman Ben Bernanke, who celebrates his second anniversary in the job tomorrow, now faces a delicate challenge. If his policy is successful, the economy will escape recession, few additional rate cuts will be needed and, paradoxically, his actions to date may end up looking excessive.

"If we end up worrying about inflation later this year that could well be the good outcome for the Fed because odds are it will mean that the economy has stabilized," said Peter Fisher, a former Fed official who is now co-head of fixed income for money manager BlackRock Inc. "It may end up looking like the pre-emptive easing was unnecessary...but that's the point of taking out insurance against the downside."

If so, that would require the Fed to quickly reverse some of its rate cuts. "They acted aggressively on the way down; that suggests they'll act as aggressively on the way up," said Vincent Reinhart, a former top Fed staffer now at the American Enterprise Institute, a Washington think tank.

But the Fed, like most of Wall Street, has already been fooled by several false dawns since the current credit crisis began in August. That means it's unlikely to sound the all-clear while financial markets remain jittery and credit markets remain tight. Yesterday's statement, while less dire than last Tuesday's, made it clear the next Fed move is far likelier to be a rate cut than an increase.

Until this month, the Fed had expected the troubles in housing and mortgage markets wouldn't spill over to the broader economy, and that inflation pressures would continue to percolate. That led it to release statements that continued to play up the risks of inflation, implying that rates might not fall much more.

That changed in January with news that consumer spending, employment and manufacturing activity had all downshifted. Concerns in the financial markets grew, as signified by the sharp drop in stocks at the start of the year.

The possibility that falling house prices will lead to more defaults and foreclosures, loss of bank capital, tighter lending and yet further declines in prices is now Mr. Bernanke's dominant concern. Yesterday afternoon, rating firm Standard & Poor's downgraded or threatened to downgrade more than 8,000 mortgage investments.

Mortgage rates have dropped in the past month, and that has enabled many borrowers with adjustable-rate mortgages either to refinance into fixed-rate mortgages or see their current mortgages adjust to rates one to two percentage points lower than would have been the case several months ago, says Doug Duncan, chief economist at the Mortgage Bankers Association. He said while that means foreclosures may be less than expected, the drop in home prices means many borrowers will be unable to take advantage of lower rates, limiting the benefit.

If home prices fall 10%, a mortgage that was originally 95% of the home's value is now about 105%, and "you may be required to bring some equity to the table in order to refinance," Mr. Duncan said.

Yesterday, many commercial banks responded to the Fed's action by lowering their prime rate, a benchmark for many consumer and business loans, to 6% from 6.5%. But long-term bond yields rose in anticipation that the rate cut would boost growth and the risk of inflation. That could lead to higher, rather than lower, mortgage rates in coming weeks.

Playing Down Inflation

Both last week's and yesterday's Fed statements played down concerns about inflation. The Fed "expects inflation to moderate in coming quarters, but it will be necessary to continue to monitor inflation developments carefully."

That view isn't universally shared at the Fed. Nine of the Federal Open Market Committee's 10 voting members approved yesterday's rate cut; Federal Reserve Bank of Dallas President Richard Fisher dissented, arguing for no cut. Three of the Fed's 12 reserve banks didn't ask for a corresponding half-point reduction in the discount rate, charged on direct Fed loans to banks, to 3.5%.

Indeed, in the past few weeks, expectations for inflation a few years from now, as measured by the behavior of Treasury-protected bonds, have risen by a quarter percentage point.

While Mr. Bernanke won't welcome that, he will likely conclude that the weaker economy he now expects, together with stable to lower energy prices, will help suppress those inflation pressures.

Fed's big rate cuts mean now could be the perfect time to refinance

January 31, 2008

By SUSAN TOMPOR
FREE PRESS COLUMNIST

The Federal Reserve took another enthusiastic whack at interest rates Wednesday, slashing short-term rates by a half point to 3%. This was on top of an emergency rate cut of three-quarters of a point last week.

Why are rates falling as fast as snowflakes in January?

"This is aggressive risk management," said Diane Swonk, chief economist for Mesirow Financial in Chicago.

The Fed is out to skirt the first U.S. recession since 2001. After Wednesday's cut, banks lowered the prime rate to 6%. Many consumers will see lower rates for some credit cards, car loans and other consumer loans.

Some fortunate homeowners are saving money by joining the refinancing boom, too.

Chuck Hixson had been looking into refinancing into a fixed 30-year mortgage, but he moved fast the minute he heard news on the radio about the dramatic rate cut by the Fed on Jan. 22.

"I heard it driving to work, and it was like, 'Today's the day,' " said Hixson, 52, who has a 2,500-square-foot home in Farmington Hills.

The 30-year fixed mortgage rate is not directly tied to action by the Federal Reserve. But long-term interest rates have fallen dramatically on recession fears.

Nationwide, the average 30-year fixed mortgage rate hit 5.88% this week, down from 6.71% as of Aug. 1, according to Bankrate.com.

The 30-year rate edged up some from last week's level of 5.57% nationwide.

Anytime the 30-year mortgage rate gets below 6%, consumers take notice.

Hixson, who bought the house in 1985, was able to take his existing home equity line of credit with a rate of 6.5% and refinance it into a 30-year fixed mortgage at 5.625%.

"I was kind of shocked that it was that cheap when I looked into it," Hixson said. He ended up talking two friends into refinancing, too.

This week, the Mortgage Bankers Association reported that its refinancing index was at the highest point since July 2003. Activity remains below those 2003 levels, however.

When homeowners are able to refinance to lower rates, it frees up cash to spend on other goods.

And even in this struggling housing market, there are still some consumers who may be able to take cash out of their homes for remodeling or other big-ticket purchases

"For the overall economy, it's unquestionably a healthy development," said Dana Johnson, chief economist for Comerica Inc.

"Whether it's enough to avoid a recession remains to be seen," Johnson said.

Officially, we are not in a recession nationwide. But the Federal Reserve has launched the fastest round of rate cuts since 1990 to overcome the widespread troubles in housing and credit markets and stop the economic slump that has hit Michigan and the industrial heartland from spreading.

Wednesday's rate cut is the fifth since September. The federal funds rate -- the rate that's used when banks lend one another money overnight -- was 5.25% last summer.

If you're looking for a silver lining, and we've got a lot of clouds here, it is that lower rates give life to economic growth.

In some cases, lower rates can prevent foreclosures. Adjustable-rate mortgages won't soar as high as they would have this spring. That helps many homeowners who had ARMs but have bad credit, too. Often those with bad credit histories can't just refinance to lower rates.

On Wednesday, we learned that U.S. economic growth slowed to an annual rate of 0.6% in October through December, far below forecasts. The annual rate was 4.9% in the third quarter.

Given today's troubles, it is essential to note that refinancing won't help everyone.

"The dilemma is that the 30-year fixed interest rate could go to zero, and there are still some people who couldn't take advantage of it," said Bob Walters, chief economist for Quicken Loans and Rock Financial in Livonia.

In Michigan, falling home values in many areas make it far tougher for people to get equity out of their homes and refinance. Others who have lost jobs will have a tough time finding a lender willing to refinance.

"The borrowers in the driver's seat are those with good credit, proof of income and either money for a down payment or equity in the existing home," said Greg McBride, senior analyst for Bankrate.com.

"If you're missing any of those three pieces, you have some big hurdles to getting approved for a refinance."

No one, obviously, knows how low mortgage rates can go this time around.

Swonk expects the Federal Reserve to cut rates again at its next meeting March 20-21.

Long-term rates, though, could even edge upward, if the U.S. economy picks up steam, thanks to rate cuts and a likely-to-be-passed stimulus package out of Washington.

So it may be wise to look into refinancing now -- especially if you have an adjustable rate mortgage and want to lock in a low fixed rate.

"If you've got a mortgage that can do it, take advantage of it," Swonk said.

"Sleep at night."

Subprime Borrowers Get Easier Terms

Mortgage Firms
Gave 370,000
A Break in 2nd Half

By MICHAEL M. PHILLIPS
January 19, 2008; Wall Street Journal

WASHINGTON -- With house prices sliding and defaults on the rise, mortgage companies negotiated easier terms with 370,000 troubled subprime borrowers during the second half of last year, according to industry data released Friday.

The assistance included new repayment plans for 250,000 borrowers in the third quarter. Another 28,000 borrowers in the quarter, and triple that number in the final three months of the year, had their terms modified, such as rate freezes.

The numbers are expected to jump further since the mortgage industry, backed by President Bush, said last month that it would expedite refinancing or five-year rate freezes for as many as 1.2 million troubled subprime borrowers, a program that is now becoming operational and wasn't reflected in Friday's lending data.

"The point is we're helping homeowners by changing the terms of their mortgages," said Steve Bartlett, president of the Financial Services Roundtable, a trade association of the 100 largest banks, insurance companies and other financial-services firms. The group is part of the Hope Now Alliance, which released the data and is coordinating the industry response to the mortgage meltdown.

Loan servicers, lenders and investors who own mortgage-backed securities have come under pressure from consumer groups, Congress and the administration to find ways to help subprime borrowers stay in their homes. An estimated 1.8 million subprime borrowers will see their interest rates jump over the next two years, unless they manage to get new mortgages or win looser terms on their existing loans.

The impending rate increases have raised fears of a new wave of foreclosures that could ripple into financial markets and the already-weakened economy.

Treasury Secretary Henry Paulson called the industry's progress in preventing defaults "heartening," but he said the administration "will look for additional measures to reach more borrowers to prevent as many avoidable foreclosures as possible." In recent weeks, Mr. Paulson has suggested that the industry might expand its help to include borrowers with nonsubprime adjustable loans.

"Obviously, much more is needed," said Rep. Barney Frank (D., Mass.), chairman of the House Committee on Financial Services. "But I welcome the progress that has been made."

Until the market dried up in recent months, lenders usually provided pricier subprime mortgages to borrowers with poor credit ratings.

Feds working on housing crisis

Treasury Secretary says mortgage protection is a priority in any solution.

Tuesday, January 8, 2008

Martin Crutsinger / Associated Press

WASHINGTON -- The Bush administration is working to combat the country's severe housing crisis but there is no simple solution, Treasury Secretary Henry Paulson said Monday, adding that a correction in the housing market is "inevitable and necessary."

Paulson said the country was facing an unprecedented wave of 1.8 million subprime mortgages that are scheduled to reset to sharply higher rates over the next two years. He said this raised the threat of a market failure and was the reason the administration brokered a deal with the mortgage industry to freeze certain subprime mortgage rates for five years to allow the housing market to recover.

"By preventing avoidable foreclosures, we will safeguard neighborhoods and communities and fulfill our responsibility of protecting the broader U.S. economy," Paulson said in a speech in New York. "However, let me be clear: there is no single or simple solution that will undo the excesses of the last few years."

Paulson said that the deal the administration brokered with the industry to freeze certain subprime mortgage rates for five years did not involve the use of any taxpayer money. Conservative critics have complained that the administration's plan represented government intrusion in the operation of markets that would end up rewarding some people who had taken out risky mortgages.

In his speech, Paulson raised the possibility that some sort of "systematic approach" may need to be developed to help homeowners with other types of adjustable-rate mortgages that are resetting to higher rates. The current plan only involves subprime mortgages, loans offered to borrowers with weak credit histories.

The steep slump in housing has been a serious drag on the overall economy. There are rising fears that the country could topple into a recession. Those worries were heightened after a report Friday showing that the unemployment rate jumped to a two-year high of 5 percent in December with job growth slowing to a crawl.

Some Home Fix-Up Tasks Are Worth Skipping

Real-Estate Agents
Say Big Upgrades
Don't Give Paybacks

By AMY HOAK
January 2, 2008; Wall Street Journal

If your New Year's resolution is to sell a home in 2008, it's probably time to start thinking about how to make that home stand out from the rest.

But before planning any projects, beware: Homeowners aren't recouping as many improvement costs as they could in recent years, according to a recent study by Remodeling magazine. In fact, real-estate agents advise clients not to overdo it, regardless of what the local market conditions are like.

"It's more important that it's neat, it's clean and it looks spacious, rather than making sure it's the top of the line," said Cheri Kuhn, owner-broker of Waters Realty in Minnetonka, Minn. She cautions her clients to bypass projects that aren't necessary.

"The thing I find with sellers: If they do a lot of remodeling, they will take the cost of the remodeling and add it to the cost of the home and ask the buyer to pay for it," she said. Often, though, sellers won't get that higher price.

The reason is that asking prices are based largely on comparisons with similar homes in the area, Ms. Kuhn said. And in the many markets that aren't exactly booming right now, buyers have more negotiating power over the price of a home.

To keep costs down and spend remodeling dollars wisely, consider the following tips.

1. Ask for advice. Before making any remodeling plans, clear your home of clutter and rent a storage unit, if necessary, to hold extra stuff while the home is on the market, said Shannon Aldrich, a Realtor licensed in Maine and New Hampshire with Keller Williams Coastal Realty. Then, get some advice from a local real-estate agent on how the home stacks up against the competition.

"I see more houses in a month than most people see in their lifetimes," said Ms. Aldrich, whose blog includes a series about getting rooms ready to sell. Sellers can use that experience to their advantage when deciding what projects to do.

When Ms. Kuhn first meets with clients -- sometimes six months before the house is listed -- she makes a prioritized list of improvements that will make a difference. Cleaning the carpets, painting the walls and removing wallpaper are common fixes. It is wise to budget for these tasks before putting money aside for more expensive projects.

2. Dig deeper. It also could pay to look below the surface by getting a home inspection before listing the property. That way, problems that could hold up a sale are addressed in advance, said Dan Steward, president of Pillar to Post, a home-inspection company in Tampa, Fla.

Some estimate that for every dollar of perceived defect, buyers want a $2 to $3 discount, Mr. Steward said. If that's true, it might pay to spend $2,500 to replace an old furnace.

Also, replacing something as necessary as a furnace helps create a favorable perception of how well a seller took care of the home, Ms. Kuhn said. If there is a problem with an essential element of the house, a buyer might think, "If that was neglected, what else was?" she said.

3. Look outside. Pay attention to exterior details like the condition of siding and windows, Ms. Aldrich said.

According to Remodeling magazine's 2007 Cost Vs. Value Report, a wooden-window replacement recovers on average 81.2% of its cost at resale, and siding replacement recovers on average 83.2% of its cost. The payoff for those projects is much better than for an upgrade that a buyer might not need. A home-office remodeling, for example, recovers 57% of its cost on average. The estimates are national averages for midrange homes, not upscale ones.

4. Spend time in the bathroom. Freshening up the bathroom doesn't have to be expensive, but it could be important.

"People will put up with a lot of cosmetic challenges in a house if they know they could use the bathroom right away," Ms. Aldrich said.

It's most important for the bathroom to be clean, but sellers should also consider replacing the fixtures, tub, sink and toilet -- if they need it, she said. Replace cracked tiles and curled linoleum.

The replacements don't have to be expensive, Ms. Aldrich added. A toilet can cost less than $250, and she recommends taller, handicap replacement toilets to appeal to an aging population.

5. Keep it small in the kitchen. The other room that often sells a house is the kitchen, but it might be best to keep renovations modest. Remodeling magazine's report found that homeowners could recover 83% of the cost of a minor kitchen remodel at resale, compared with 78.1% of a major kitchen remodel.

Ms. Kuhn cautions her clients not to replace refrigerators, stoves or dishwashers. Buyers considering remodeling the kitchen will likely have their own preferences, she said.

Along those same lines, sellers should replace a countertop if it is crumbling but not if its only fault is that it is outdated, Ms. Kuhn said. Even then, seriously consider material costs: There is no need to update to granite unless the competition has granite countertops as well.