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By Daniel Kruger /
March 24 (Bloomberg) -- Forget lower interest rates. For the Federal
Reserve to keep the financial markets from imploding it needs to buy
troubled mortgage bonds from banks and securities firms, say the
world's biggest Treasury investors.
Even after cutting rates by 3 percentage points since September,
expanding the range of securities it accepts as collateral for loans
and giving dealers access to its discount window, the Fed has been
unable to promote confidence. The difference between what the
government and banks pay for three- month loans almost doubled in the
past month to 1.69 percentage points.
The only tool left may be for the Fed to help facilitate a Resolution
Trust Corp.-type agency that would buy bonds backed by home loans,
said Bill Gross, manager of the world's biggest bond fund at Pacific
Investment Management Co. While purchasing some of the $6 trillion
mortgage securities outstanding would take problem debt off the
balance sheets of banks and alleviate the cause of the credit crunch,
it would put taxpayers at risk.
``An RTC-type structure is interesting, and it may not be that much of
a burden on taxpayers in the long run,'' said Barr Segal, a managing
director at Los Angeles-based TCW Group Inc. who helps oversee $80
billion in fixed-income assets. The government should purchase the
mortgages and reissue ``debt that's backed by the U.S. government and
there you go, you've unclogged the drain,'' he said.
Bill Rates Plunge
New York Life Investment Management is considering buying ``high-
quality mortgages,'' said Thomas Girard, a senior ****tfolio manager at
the New York-based insurer. ``At some point here you've got to
increase your allocation to non-Treasury securities.''
Mortgage bonds rallied last week. Yields on the securities fell to an
average of 1.25 percentage points more than Treasuries from 1.57
percentage points on March 14, according to Merrill Lynch & Co.'s
Mortgage Master Index. The so-called spread is still twice as wide as
the average for all of 2007.
Investors, averse to holding most any debt except Treasuries, drove
rates on three-month bills to 0.387 percent on March 20, the lowest
since 1954. Rates on the securities, the safest assets next to cash,
tumbled 0.59 percentage point last week to 0.57 percent. They were as
high as 4.29 percent as recently as Oct. 15. The rate climbed to 0.91
percent as of 1:17 p.m. in New York.
`Very Helpful'
``Something like that would be very helpful, but the Fed was not
designed to and shouldn't assume a huge amount of risk on behalf of
taxpayers,'' said Alan Blinder, a Princeton University professor and
former vice chairman of the central bank. ``That should come out of
the elected parts of the government, which means the administration
and Congress.''
President George W. Bush and Treasury Secretary Henry Paulson have
resisted calls urging the use of government funds or guarantees to
stem a record amount of mortgage foreclosures, the root of the
financial crisis, preferring that the markets resolve the trouble.
Bush said March 15 he wanted to avoid ``bad policy decisions'' that
would do more harm than good.
President George H.W. Bush, the current president's father, signed the
1989 law which created the RTC to dispose of the assets of insolvent
savings and loans banks. From 1986 through 1995, 1,043 savings banks
with over $500 billion in assets failed, costing taxpayers $75.6
billion, according to a Federal Deposit Insurance Corp. analysis.
Joint Action
The Fed, the Bank of England and the European Central Bank are
exploring the feasibility of using taxpayers' money to shore up the
mortgage-backed securities market, the Financial Times re****ted on
March 22, without saying where it obtained the information. A Fed
official denied to Bloomberg News that day that it's in discussions to
buy mortgage debt.
Smaller steps are already being taken. The Bush administration reduced
the amount of capital Fannie Mae and Freddie Mac are required to hold
as a cu****on against losses. The March 19 agreement allows the
government-chartered companies, the largest sources of money for U.S.
home loans, to expand their purchases of mortgages by as much as $200
billion.
The Fed has also lowered borrowing costs, opened the so- called
discount window to investment banks and arranged the sale of Bear
Stearns Cos. since March 16 to ease financial-market turmoil. The
world's biggest financial companies have posted at least $195 billion
in writedowns and credit losses tied to subprime mortgages and
collateralized debt obligations as of March 20, according to data
compiled by Bloomberg.
`Done That Already'
JPMorgan Chase & Co. agreed to pay about $240 million for the fifth-
largest securities firm in a transaction that includes as much as $30
billion of financing provided by the Fed for Bear Stearns's ``less-
liquid'' assets.
``In a sense they've done that already with Bear Stearns,'' Michael
Materasso, senior ****tfolio manager and co-chairman of the fixed-
income policy committee at Franklin Templeton Investments, said of the
government taking on the risk of owning mortgage securities. ``This
was not just a tem****ary situation. The process has begun, the
question is how far can it go?''
Franklin Templeton manages $110 billion of bonds. Materasso is based
in New York.
A March 13 proposal by Senator Christopher Dodd and Congressman Barney
Frank that the Federal Housing Administration insure refinanced
mortgages after lenders reduce the loan principal to make payments
more affordable to homeowners ``is the next step,'' Senator Charles
Schumer, a New York Democrat, said in a Bloomberg Television interview
on March 19. It's a ``broader step, but not as broad as RTC,'' he
said.
For Pimco's Gross that's not enough. ``If Wa****ngton gets off its high
`moral hazard' horse and moves to sup****t housing prices, investors
will return in a rush,'' he wrote in a note to investors published
Feb. 26. Gross, who runs the $122 billion Total Return Fund from
New****t Beach, California, didn't return calls seeking additional
comment.
An RTC-like entity may not be ``the best idea, but maybe it's the idea
that gets us through this,'' said New York Life Investment
Management's Girard. ``The likelihood of it happening has certainly
increased.''
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To contact the re****ter on this story: Daniel Kruger in New York at
dkruger1@[EMAIL PROTECTED]
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