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RISMEDIA, Oct. 2, 2007-(MCT)-When the Federal Reserve lowered interest rates this month, critics complained that Fed Chairman Ben Bernanke was bailing out homeowners who should never have taken out all those wacky no-down-payment, no-documentation, no-fixed-rate mortgage loans.

Have no fear, friends.

Bernanke’s rate cut has not drastically slashed mortgage rates. In fact, for the most reliable loans — 30-year fixed-rate mortgages — rates actually went up in the past two weeks instead of down.

The average rate for a 30-year mortgage rose from 6.31% on Sept. 18, when Bernanke cut the federal funds rate, to 6.42% last week. And it will likely get even pricier if the Fed cuts rates further.

“People had expectations that what the Fed was doing would help turn the housing market around, but we’re not getting any kind of bump from the rate cut,” said T.J. Knowles, a mortgage broker with CalBrokers in San Diego.

“What if they gave a rate cut and nobody came?”

Richard Yamarone, chief economist at Argus Research, calls it “the Bernanke conundrum,” the mirror image of the “Greenspan conundrum” of 2005. At that time, Alan Greenspan boosted interest rates, only to see mortgage rates drop. Now the opposite has come true.

How did this conundrum occur? In five easy steps:

–The Fed slashes the federal funds rate — a key benchmark for other interest rates — from 5.25% to 4.75%, with the likelihood that more cuts may be in the offing. Many Wall Streeters predict it will be 4% by December.
–To create the rate cut, the Fed unleashes a flood of cash onto the market, raising the specter of inflation.
–Investors in long-term Treasury bills — including China and other foreign countries — say, “If inflation’s gonna kick into overdrive, my T-bills are going to crash like a cement souffle.” So they start selling their Treasuries.
–The sell-off in T-bills pushes the Treasury to boost the interest rate the bills offer to attract new buyers.
–When T-bill rates go up, long-term mortgage rates go up, because the two typically go arm-in-arm.

There also is no discount for people wanting to buy a home with a relatively safe, secure 30-year mortgage. Nor is there any relief for homeowners with adjustable loans who want to refinance with fixed-rate mortgages.

But what about adjustable rate mortgages, or ARMs, which lie at the heart of the crisis? Well, ARM rates have gone down nicely since the Fed made its decision. In the past week, five-year ARMs dropped from 6.21% to 6.15%. One-year ARMs slid from 5.65% to 5.60%.

It was the fourth straight week that ARMs declined. And they could drop further. Most ARMs are tied to the London Interbank Offered Rate, or LIBOR, which averages out the interbank deposit rates of banks throughout the world. Because the Fed has such an influence on those rates, a cut in the federal funds rate helps bring down the LIBOR. There’s a major catch, however. Many mortgage brokers that once specialized in ARMs have gone bankrupt or left the market. The survivors are so fearful that they’ve tacked new costs and requirements onto their loans, which make it more difficult for homeowners to qualify for a refinancing.

“The rate is not the only issue,” said Knowles at CalBrokers. “A lot of programs that people got their loans under are now gone. Or the underwriting is so stringent that people can’t qualify. Or the values of the borrowers’ homes have gone down.”

The downward shift in home values makes it hard to refinance, since few lenders are willing to lend more money than the underlying value of the property.

“The Fed rate cut has done nothing for most home buyers,” said Bob Schwartz, a San Diego real estate broker who operates, an online realty site. “It certainly is not going to forestall regional real estate recessions, like the one San Diego is in.” The leaders at the Fed must have known their rate cut might have this effect, since most of them lived through the Greenspan conundrum of two years ago.

So if the Fed wasn’t aiming to help out home borrowers, what was it doing?

The most benign interpretation is that the half-point drop was needed to invigorate the lending market, which was paralyzed in fear this summer as the problems associated with mortgages worsened.

The Fed made a half-point cut to its discount rate in August to unfreeze the commercial credit market, cutting it another half point on Sept. 18. Wasn’t the first cut enough to kick-start the stalled market for commercial lending? And why cut the federal funds rate, which has less to do with commercial credit?

A more callous interpretation of the Fed cut was that the move was designed solely to help the stock market, which — in better days — would have dubbed Bernanke as “Beatified Ben” to go along with “Saint Alan” Greenspan. Stock prices are still at giddy highs, propelled by investors who don’t recognize that the rate cut was a giant warning flag that all is not going well for the economy.

The most intriguing interpretation is that the Fed knows something about the economy that is scarier than anything the public imagines.

John Browne, an economics analyst in Florida whose online Financial Intelligence report has been prescient about problems with the mortgage market, suggests that the Fed, which has access to provisional government data before it hits the public, has begun to fear that the economy could get much worse than many prognosticators now think possible.

“To their horror, we feel our Fed saw a mild recession being driven by a solvency crisis (i.e., a freeze in commercial lending) into a deep and massively damaging depression,” Browne said. “We think (the Fed) was so shocked at the prospect of a looming recession that they acted in a manner that surprised most market practitioners.”

“Massively damaging depression”? That’s far more than most market analysts would commit themselves to, although Yale economist Robert Shiller says the current situation reminds him of 1929. But if we’re going to do some retrogressive time traveling, a more likely destination might be the 1970s — an era of stagflation rather than depression, when inflation and economic stagnation hit the nation at the same time.

“I firmly believe we’re in a stagflationary environment that will be marked by economic growth that will be well below historical trends,” said Michael Pento, senior market strategist for Delta Global Advisors, an investment firm in Huntington Beach. There’s no telling whether Bernanke agrees with Pento. But with two rounds of rate cuts in a month, it’s clear that* something* spooked the Fed. Whatever it was, the Fed’s actions offered little immediate aid to the debt-heavy homeowners who are at the heart of the economic turmoil.

Copyright © 2007, The San Diego Union-Tribune
Distributed by McClatchy-Tribune Information Services.