What is the impact on Real Estate Investors and Hedge Funds when the Fed buys bad debt

What is the impact on Real Estate Investors and Hedge Funds when the Fed buys bad debt.

Many economists, including leaders of the Fed and the Treasury has surmised that stabilizing home prices is the best way to slow or stop the current economic issues. However, they cannot arbitrarily stabilize home prices. The best thing that they can do, is to work to lower interest rates. By lowering rates, the thinking goes, buyers who are on the sideline will purchase homes.

The market was asking for it and the Fed did not disappoint. “The Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month,” reads the Fed’s press release. In addition, the FOMC guaranteed a federal funds rate of 0–0.25 percent until mid-2015, an extension from the previous target of 2014. Furthermore, the Fed will continue the so-called Operation Twist program until the end of the year as planned, in which the bank sells shorter term securities and uses the proceeds to buy longer term securities for a total consideration of $667 billion.

Going back to a supply and demand principal, once the demand equals supply, prices stabilize. Therefore, if the Fed, via lower interest rates can entice enough buyers to purchase homes, at some point home prices stabilize. Stabilizing home prices will have a myriad effect on many areas of the economy. It will help those directly involved in Real Estate, as well as ancillary business such as home builders, developers, etc. Home values are also considered a good indicator of the economy as a whole, so stable values will have a trickle-down effect into consumer confidence as well as other unrelated areas of the economy. In the end, the Fed buying MBS to lower rates is not a cure all, but it appears to be a very substantial step towards trying to move the general economy forward.

In a statement after the F.O.M.C. announcement, the New York Federal Reserve, which handles the bond purchases, said the purchases will include bonds ranging for less than 2 year to 30 years, with “an average duration of between 5 and 6 years.”

“The distribution of purchases could change if market conditions warrant,” the New York Fed said in a statement, “but such changes would be designed to not significantly alter the average duration of the assets purchased.”

Economists disagree about how much the new round of debt purchases — a reprise of an initial, $1.7 trillion round that ended in March — will have on spurring consumer and corporate demand.

Lower long-term interest rates in theory should ripple through the markets, affecting other rates, like those of 30-year, fixed-rate mortgages. That could encourage homeowners to refinance into cheaper mortgages, though it would not help the millions of Americans facing foreclosure.

But there are several significant risks. The new actions are likely to further drive down the value of the dollar, which as fallen about 7.5 percent since June against the currencies of major trading partners. That could exacerbate the trade and exchange-rate tensions that have threatened to unravel cooperation among the world’s biggest economies.

Moreover, the Fed is exposing itself to the risk that the assets it has purchased, like the $1 trillion in mortgage-related securities on its balance sheets, could shrivel in value as interest rates rise. That could reduce the amount of money the central banks turns over to the Treasury each year, and expose the Fed — which has been attacked for failing to prevent the 2008 financial crisis — to further criticism.

The Federal Open Market Committee (FOMC) launched a new round of quantitative easing (QE) Thursday, dubbed QE3. The Federal Reserve will buy up to $40 billion of mortgage-backed bonds per month in order to boost the housing market and increase employment.

The Fed and Your House ….

The underlying improvement in housing demand is still very reliant on cash buyers and investors,” notes Paul Diggle of Capital Economics, who does not believe mortgage rates will fall dramatically. “Admittedly, low bond yields and savings rates more generally are probably playing a part in the strength of investor demand for housing.”

Lower rates could cause a boost in refinances, but so many have already refied at record low rates that it would take a pretty large drop to lure more in, given the fees and hassle involved. And of course negative equity keeps millions of potential refinancers out of the game. The government’s refinance program for underwater borrowers (HARP) has helped over half a million borrowers get lower rates since the beginning of this year, but unless you have a Fannie Mae or Freddie Mac backed loan, you’re not eligible.

 

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