Treasury to Fed: Buy Troubled Mortgage Bonds
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 doubled in the past month to 2.03 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, the manager of the world's biggest bond fund at Pacific Investment Management Co., Bill Gross, said. While purchasing the 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," a managing director at Los Angeles-based TCW Group Inc. who helps oversee $80 billion in fixed-income assets, Barr Segal, said. 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.
New York Life Investment Management is considering buying "high-quality mortgages," a money manager at the New York-based insurer, Thomas Girard, said. "At some point here you've got to increase your allocation to non-Treasury securities," he said. 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% 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%. They were as high as 4.29% as recently as October 15.
"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," a Princeton University professor and former vice chairman of the central bank, Alan Blinder, said. "That should come out of the elected parts of the government, which means the administration and Congress."
