Re: 30-year Treasuries, Fed policy and the 2001-? recession: resp

["Niggle, Christopher" <Christopher_Niggle@xxxxxxxxxxxx>]

Henry:  Greenspan was concerned with the stock bubble in his public
statements, but as I recall the Fed moved to tighten in 1999 because they
interpreted the data re unemployment, economic growth vs their estimate of
capacity growth, and various inflation measures as time to
tighten....probably thought the economy was close to their estimate of the
NAIRU (or close to everybody else in their constituency's estimate for the
NAIRU)and growing too fast, so that inflation and inflationary expectations
were in danger of increasing.  In retrospect they were probably wrong to
tighten.

And I agree that one of the deflationary/depressing factors was the US
government's budget swinging toward a high employment surplus, which had to
contribute to slowing demand growth.

Paul: I don't know of ANY post WWII recession that wasn't preceeded by Fed
tightening; so I agree with you.  That of course doesn't mean that the only
factors causing those recessions were the Fed's policy moves; in many cases
profits and profit rates were also declining  before the Fed tightened.  But
still, it is easy to make a case for the Fed over-reacting to inflation or
inflation signals.

Chris

-----Original Message-----
From: Henry C.K. Liu
To: Niggle, Christopher
Cc: pkt@xxxxxxxxxxxxxxxx; a-list@xxxxxxxxxxxxxxxxxxx;
TheNewForum@xxxxxxxxxxxxxxx
Sent: 7/21/2003 11:42 AM
Subject: Re: 30-year Treasuries, Fed policy and the 2001-? recession

Chris:

Greenspan's irrational exuberance warning was given when the DJIA was
around 8000, lower than today's 9000.  There is no doubt that the Fed
raising rate in 1999-2000 contributed to the downturn but the real cause

was the Clinton budget surplus.

There is no reason whatsoever for government to even incur a budget
surplus, except to slow down the economy. A budget surplus works only to

reinforce the business cycle which then requires a budget deficit to
correct. The problem with both the Clinton budget surplus and the Bush
tax cut and deficit is that the money went to the wrong hands that did
not spent it but looked for high returns from investment.

Even with Clifton's debt bubble, remember there were talks of the end of

the business cycle? (I posted on the subjected then), but Summers was
seduced by the political prospect of a surplus and debt reduction while
Greenspan was warning about irrational exuberance. Well, if you play by
the rules of the business cycle, a budget surplus must be followed by a
recession, which was exactly what happened. Then Summers came out with
his ridiculous slogan of "Debt reduction creates fiscal space", claiming

that debt reduction can be stimulative. What actually happened was
shifting public debt to private sector debt, which is the ingredient of
a bubble. Federal debts do not cause bubbles, only private debts do.

Clinton did not produce a surplus, he merely put a stop to the expansion

and call it a surplus. It is the same as corporate profit rose in the
past few years not because sales had gone up but because layoffs and
halts in investment reduced cost. The rate of contraction was faster
than the drop in revenue already in stream. And it was booked in
quarterly reports as profit. There is no way a smaller business can
produce more profit than a large one. Government budget surplus works
the same way on a national scale. A surplus remove money from the
economy and contracts it which will result in deficits down the road.

Greenspan repeats his arguement that derivatives "flatten" the business
cycle and moderate "extraordinary shocks" and "dramatic declines" in
share prices. He ignores the fact that this is achieved by transfering
unit risk to systemic risk. There was a time when the Fed was supposed
to worry about systemic instability by keeping unit errors from
accumulating into systemic problems.  But the new monetarism seems to be

swimming in a different ocean.


Also, Greeenspan appeared thankful that "cash out" refinancing of home
mortgages was holding up the "non-bubble" of the hosuing sector. He
conviniently forgets that refinancing is fatal to CMOs which is a large
part of the derivative market, as well as interest rates swaps.  Most
economists know that there is no free lunch, that life, including
economics and finance, is always a trade off.  Greenspan's whistle in
the dark confidence about fear of derivatives as WMD is based on the
knowledge that he can bail out the system easier than he can bail out
GE.

Central banks in desperate times would look to hyper-inflation to
"provide what essentially amounts to catastrophic financial insurance
coverage," as Greenspan suggested in a November 19 2002 address on
International Financial Risk Management to the Council on Foreign
Relations (CFR) in Washington.

The problem is that we are fast approaching a scale where it would be
too big even for the Fed.  That point has already been reached in the
foreign exchange market, and it is on the verge in the debt
market.

Henry


Niggle, Christopher wrote:
>  Henry: interesting and informative post, most of which I agree with
except
> your comment below that all the post-WWII recessions EXCEPT for this
one was
> caused by the Fed tightening monetary policy.  The Fed raised rates in
1999
> and 2000, which was probably one of the factors leading to the
downturn,
> right?
>
> It reversed its policy quickly as it saw the recession developing of
course,
> and it is likely that a recession would have occurred at some time w/o
the
> move toward higher rates, since profits were falling, excess capacity
was
> showing up, etc., but still - consider the timing.
>
> Chris
>
> -----Original Message-----
> From: Henry C.K. Liu
> To: pkt@xxxxxxxxxxxxxxxx; a-list@xxxxxxxxxxxxxxxxxxx;
> TheNewForum@xxxxxxxxxxxxxxx
> Sent: 7/19/2003 2:54 PM
> Subject: 30-year Treasuries
> Importance: Low
>
> The following is a composite summary of recent market reports from a
> variety of media sources interlaced with my comments to give my sense
of
>
> an overview picture.
>
> The 30-year bond (US30YT=RR) gained 8/32 to yield 4.68 percent on
> Friday, July 11 shrugging off some of the pressure exerted since
> Wednesday, July 9 2003, when Treasury Undersecretary Peter Fisher
> announced his intention to resign.
>
> Fisher played a key role in the elimination of the 30-year bond back
in
> October 2001 and speculation had mounted over the chances of its
> reintroduction once he leaves.
>
> The Washington Post reported in mid May that Treasury Undersecretary
for
> Domestic Finance Peter Fisher had withdrawn his name for consideration
> as president of the New York Fed.
>
> The market believed that as long as Pete 'The fixer' Fisher
> (LTCM) remained in his current position at the Treasury, the 30-year
> will
> not be reinstated. It was Fisher's decision to eliminate the 30-year
> bond on Halloween day 2001 and his reputation and credibility are tied
> to it.  Recently, while still at the Treasury, he said rumors of the
> return of the 30-year 'aren't worth spit'.
>
> With barely any warning to the financial markets, Fisher announced in
> October 2001 that Treasury would no longer issue 30-year bonds--the
> so-called benchmark securities that had set prices for the whole
> bond market. The rationale was that the government was paying too much
> in interest for the long bond. Besides, big budget surpluses had
reduced
> the need for the 30-year.  It is cheaper for government to issue new
> money (non-interest bearing state credit instrument) through the Fed
> than to issue sovereign debts through the Treasury.  Of course Fisher
> did not point out that an sustainable long term monetary policy
requires
>
> a constant but low rate of inflation - which is essential the money
> holder's interest cost to the state money issuer.  Thus money in a
> working growth economy is not really interest free.
>
> Greenspan said in the Q&A during his July 15 Humphrey Hawkins
testimony
> to the Senate that while the Fed has no opinion of the 30-year bond
> policy, it is obvious that things have change:  meaning federal
deficits
> have replaced federal surpluses in the foreseeable future.
>
> Things have indeed changed dramatically, with the federal deficit in
> 2003 hitting $450 billion or 4.5% of GDP, not even counting
> war/occupation costs. And the government's bond rates have
> fallen, causing a boom in bond prices until recently.
>
> Many market participants think the Treasury should reverse its
> decision--and start issuing new 30-year bonds. Doing so would help
> government finances, give investors a long-term, risk-free investment
> option, and allow corporations to more easily price long-term debt.
> There was a time this would be true. The long bond used to be the
safest
>
> hedge instrument before the emergence of structured finance. The
entire
> fixed income sector was based on the long bond.  Today, derivatives
and
> swaps have changed the meaning of hedging, turning it from a risk
> management device to a risk taking play for high returns for
> speculators. Structure finance, not withstanding the claim of
Greenspan
> that derivative provide market stability.  Structured finance
> dis-integrates long term security into short term differentials, with
> profit driven by volatility. A stable market is bad news for hedge
> funds.  Structured finance has reduced the relevance of the long bond.
>
> The term fixed income has come to mean fixed only for the duration of
> the derivative contract term, even for the long bond.  Widows and
> orphans trust funds, pension funds as well as Freddie Mac mortgages
have
>
> all been exposed to inappropriate risk by derivative plays, at the
mercy
>
> of hedge funds.
>
> It wouldn't be the first time the government changed its policy on the
> long bond. From the 1950s through the middle of the 1970s, 30-year
bonds
> were issued only sporadically. It was not until 1977 that Treasury
> started using large quantities of 30-year bonds to fund growing and
> permanent deficits.
>
> The theory for bring the long bond back is that Treasury would gain by
> tapping into institutional and foreign investors attracted to the
> 30-year. More buyers means lower rates for the government. And a
30-year
>
> issue would lock in low rates for the next 30 years, holding down
> interest payments and reducing future deficits. But with agencies play

> derivates, it is not clear that government actually saves money by
> issuing the long bond. Even though new 10-year notes cost the Treasury

> 0.8 percentage points less in interest than 30-year rates today, in a
> decade, they might have to be refinanced at higher rates. "The U.S.
> Treasury should be at least as smart as homeowners," notes David A.
> Wyss, chief economist at Standard & Poor's, a unit of The McGraw-Hill
> Companies.  But it is, even with the 30-year bond because the market
> value, therefore the effective yield of the long bond is not at all
> fixed over its life time.  The the net value of government long debt
is
> not constant at any moment in time, nor its effect on the credit
market.
>
>   The only thing fixed is the interest payout by the government on the

> outstanding long bonds. Since new long bonds are issued at market
rates,
>
> the average cost of long bonds to the government is not constant.
> Besides, what Fisher missed is that the purpose of the long bond is
not
> to fund government cash needs, but to provide a benchmark for the
credit
>
> market.  The interest cost to the government has little macroeconomic
> consequence, except to those who misunderstood macroeconomics as a
> branch of accounting.
>
> The conventional wisdom is that reissuing the 30-year bond would also
> offer risk-shy investors more choices, helping both institutional
> investors with a long-term investment horizon and individuals building
a
>
> retirement portfolio. Correctly done, investing in a 30-year Treasury
> bond means that "people who are 35 or 40 years old who are saving for
> their retirement would know exactly what they're going to have in 30
> years," says Wharton School economist Jeremy Siegel. While other
> long-term securities exist, none are truly risk-free.
>
> It is argued that bringing back the long bond would also help pension
> funds, insurers, and corporate borrowers. Pension funds, hit hard by
> market volatility, could better protect returns by upping their
> long-term risk-free holdings. Insurers could better match long-term
> investment to long-term liabilities. But few retirment accounts are
> satisfied with long bond yields.  No pension fund manager can keep
> his/her job for long if the assets under management is excessively
heavy
>
> in long bonds. And issuers had been chasing high returns by borrowing
> short term to invest in long bonds, and will be caught short when a
> reverse yield curve takes over, as it did during the final years of
the
> Clinton "boom".
>
> And it is also argued that a reissued 30-year would help companies
price
>
> their own long-term debt, attracting more investment. But short term
> debts are now routinely used to finance long term liabilities, making
> the long corporate bond a wall flower, a mere underlying benchmark to
> calculate spread.  GE cannot afford to borrow long term debt. It is
the
> low rate GE commercial papers that give GE the spread to be a
financial
> powerhouse.  GE is extremely vulnerable to deflation and to reverse
> yield curves.
>
> It would be tough for Treasury to reverse the decision to drop the
long
>
> bond. To guarantee buyers sufficient liquidity, Treasury would have to

> commit itself to issuing 30-year bonds for several years, which makes
> sense only if deficits are going to persist--and that's something the
> Bush Administration isn't willing to admit yet, despite irrefutable
> evidence.
>
> Shock waves from Greenspan virtually disavowing unconventional policy
> means (buying long bonds) have fully eclipsed the gains set in motion
by
>
> his original references to deflation. Longer-dated bonds proved
> particularly vulnerable, especially after the release of
> stronger-than-expected June retail sales. Their premium evaporated
just
> as a record $450 billion 2003 deficit was predicted by the White House

> following elevated hopes for a reinstatement of bond issuance recently

> with Fisher's resignation.
>
> The curve steepened sharply, not only pricing in economic recovery but
> also the likelihood that Fed funds will be held low, so long as Fed
> reflation efforts continue. While Greenspan digged hard for additional
> grounds for optimism on the economy, he made it clear that while on
the
> verge of price stability rates would be kept low. The September bond
> closed over 2 points lower at 112-16, while the 2-year note and
30-year
> bond spread jumped 10 basis points from pre-testimony levels to +350
> basis points -- fresh 11-year wides. Fed funds futures predicted
25-30%
> odds of another quarter point cut.
>
> The bond market has been on a roller-coaster ride recently as
investors
> struggled to divine the intentions of the Fed. Gambling that
> the Fed would buy bonds to help ward off deflation, investors piled
into
> the market in mid-June, sending the yield on the 10-year Treasury note
> to a 45-year low of 3.1%. But when the Fed opted to merely trim
interest
> rates on June 25, investors turned tail and sold bonds.
>
> The coup de grâce came on July 15 as Chairman Alan Greenspan forecast
> faster economic growth and seemingly all but ruled out bond purchases
by
> the Fed. The bond market quickly tanked. Greenspan tried to turn the
> tide the next day by saying he hadn't taken bond buys off the table,
but
>
> the damage had been done, and the 10-year yield ended the day at close

> to 4%.
>
> The wild market fluctuations have left a sour taste in the mouth of
many
> market participants. Some mutter about being manipulated and misled by
> the Fed. "Greenspan has lost some credibility with the market," says
> Melvyn B. Krauss, senior fellow at Stanford University's Hoover
> Institution.
>
> Of course, some of the rise in bond yields is due to growing hopes for

> an economic rebound -- a phenomenon to be welcomed but highly unlikely

> given the poor fundamentals, geo-political uncertainties, and policy
> fixations.  Yet the rapid increase in long-term interest rates
> also reflects wariness about the Fed floundering with wishful
thinking.
> If investors feel they can't count on a predictable and level-headed
> Fed, they're apt to push bond yields and long-term rates up higher
than
> justified by the perceived or wishful strengthening economy alone.
>
> A premium for Fed risk could even lift rates to the point where they
> hurt the very economic recovery the bulls are anticipating. "This is
not
> an economy that's going to take off like a rocket," says former Fed
> Governor Lyle Gramley, now senior economic adviser for Schwab Capital
> Markets. "I would be more comfortable if 10-year yields were at 3
1/2%,
> instead of 4%."  It is an economy that will most likely explode during
a
>
> unprepared takeoff from leaky ideological O rings.  It will move from
> unpleasant recession to fatal catastrophe.
>
> The federal budget deficit is ballooning. The White House on July 15
> predicted a financing shortfall of $455 billion in fiscal 2003, and
$475
> billion for fiscal 2004, which may well come in at $600 billion. The
> forecast fanned fears in the bond market of stepped-up sales of
Treasury
>
> securities, helping to send prices even lower and yields higher.
>
> Dealers, banks, and hedge funds are sitting on large bond positions
they
> built up via so-called carry trades -- borrowing money at low
short-term
> rates and then investing it in longer-dated securities. This is what
is
> behind bank profit in the latest quarter, which most have hailed as
good
>
> news rather than the bad news that it actually represents. But with
the
> value of those bond investments falling, there's a risk of a major
> sell-off as those trades are unwound, says economist Henry Kaufman.
> Kaufman has seldemn if ever been wrong on the economy in his long
career
>
> on Wall Street.
>
> Fed policymakers egged on investors in June with warnings about the
> dangers of falling prices, capped off by Greenspan's colorful comments
> on the need to build a "firebreak", Greenspan?s word in a June 3
speech,
>
> against deflation. In private meetings and public speeches, Fed
> officials suggested they were deliberately trying to guide long-term
> rates lower and left open the possibility of buying bonds to help
their
> chances.
>
> There's no doubt that investors read more into some comments than the
> Fed intended. They ignored repeated warnings by Greenspan and other
Fed
> policymakers that the risk of deflation was, after all, remote.
Instead,
> they snapped up bonds in the mistaken belief that a desperate Fed
would
> bail them out by buying up their securities. "The market has got to
take
> some responsibility for its own actions," says former Fed Governor
> Laurence H. Meyer.  This is rational expectation at work to the point
of
> irationality.  The detonator is the Fed's claim that the risk of
> deflation is remote.  Not even taxi drivers believe it.  Even the BIS
is
> calling for anti-deflationary measures for all of the world's central
> banks.  Greenspan's war plan is always to anticipate phantom inflation
> and deny real deflation.  When Greenspan again recite his mantra that
> America enjoys the highest stabdadr of living, presumably due to his
> monetary genius, he was interrupted by the senator from Vermont, the
> Greenspan should visit Vermont to find out how hard life really is in
> America.  The high standards of living is limited to the few who
> Greenspan's policies had been designed to favor, namely financiers and

> top executives.
>
> The markets' eroding confidence in the Fed has consequences. The
danger
> grows if investors feel so threatened by what they see as an unsteady
> Fed policy that they demand ever higher risk premiums on Treasury
bonds.
> Greenspan has been repeating his promise to buy long term treasuries
if
> the economy needs it. His out is that the economy never needs it.
> Greenspan is milking the economy dry to maiantain the financial
markets.
>
>   And, American voters, hurt by the economy, will turn against the
> financial markets and its managers.
>
> The unconventional means suggested by Bernanke is that the Fed can buy

> 10 or 30 year treasuries from open market operations and create new
> reserves in the banking system. This drains treasuries from the market

> and makes each treasury worth more as a result. This allows the
sellers
> to offer lower yields to the new buyers and still be able to sell
them.
> Simple supply and demand at work.
>
> As the yield on the 10 or 30 year treasury falls all other rates that
> are tied to it fall, corporate debt, fixed and floating home mortgages
> of all durations. When Greenspan says he is ready and willing to buy
> long treasuries to stimulate the economy what he means is that he will
> manipulate mortgage rates down to attract new buyers into housing and
> cause another refinance boom, which has come to a screeching halt in
> recent months.
>
> The 30 year fixed rate mortgage accounts for about 65% of all mortgage
> loans in the US. The rate on that loan is determined largely by the
cost
>
> of borrowing money at Fannie Mae and Freddie Mac. Their borrowing cost

> is determined by the yield on the 10 year treasury because most 30
year
> mortgages are refinanced with 10 years. That rate will be the 10 year
> treasury yield plus a risk premium for lending money to Fannie and
> Freddie versus lending money to the US government. As the yields on
> the 10 year US treasury fall lenders to Fannie and Freddie are willing
> to accept a corresponding reduction in rate they will accept from
Fannie
> and Freddie for lending money to them as well. Fannie and Freddie then
> pass this reduction on to the banking and mortgage industry in the
form
> of lower PAR rates or cost of money for mortgages. The banking and
> mortgage industry then pass this reduction on to each home owner by
way
> of lower mortgage rates.
>
> This process has been going in a passive manner for the past year, as
> the Fed has indirectly been the cause of lower mortgage rate over the
> course of this year. This is Greenspan housing bubble after his eqity
> bubble burst.
>
> For the past year the Fed has been increasing money supply by buying
> treasuries form the banks and replacing them with bank reserve, high
> power money. The banks in turn have been turning around and re-buying
> treasuries on the open market. The result has been lower long term
rates
> and a refinance boom in the US housing market.
>
> The agencies have also been hedging their interst rate exposures with
> derivatives. There is on-going investigation that will eventually
reveal
> very unwelcome disclosures, the tip of the iceberg having been hinted
in
>
> recent weeks.
>
> The Fed's primary supply side game plan was to encourage banks to lend

> to corporations which has not occurred becuase of overcapacity that
> erodes pricing power and proifts. The reduction in mortgage rates
> during this period was a peripheral bonus that sustained consumers
> spending by the Fed repricing long term debt to support the economy
> while the Fed attempted to get corporations to borrow. The housing
> refinance boom provided cash-outs from appreciated equity resulting
from
>
> the housing bubble as well as lower loan payments to finance consumer
> spending. When the housing bubble bursts, negative equity will create
> chaos in the financial markets through the collapse of collateralized
> martgage obligations (CMO).
>
> Greenspan appears to have shifted Fed policy to preempt deflation and
> aggressively move rates down ahead of the economic contraction and is
> now preemptively telling the market he may move out on the yield
> curve to long bonds and buy long treasuries with the explicit goal of
> driving mortgage rates down.
>
> The reason he is being so vocal about his possible intentions to buy
> long term treasuries is to ensure hedge funds and most importantly the

> soeverign debt markets are hedged against falling rates before it
> occurs. It is a warning or "heads up" so to speak to them.
>
> Last summer the duration gap problem at Fannie Mae was the direct
result
> of Fannie Mae not anticipating that the 10 year treasury yield would
go
> below 4%. When it did their duration gap widened and they lost
enormous
> amounts of money. The reason they were not properly hedged is that
they
> anticipated that the reduction in Fed Funds and corresponding increase

> in money supply would depreciate the dollar and increase the potential

> for future inflation in the US economy which would have been reflected

> in rising 10 year treasury yields rather than falling.
>
> But, because the corporations refused to borrow and banks refused to
> lend, in a classic Keynesain liquidity trap, and the rest of the world

> continued to buy US treasuries with their trade surpluses from US
> consumers, the dollar did not depreciate against the Yen and Euro
until
> recently and by not much. Even now the euro is only back at the
exchange
>
> value it adopted at the time of its intrduction. This was the first
> major international empirical signal that this was not the same type
of
> economic contraction that we have experienced since the end of WW2.
>
> Every other post war recession has been the result of the Fed
> maintaining too tight a monetary policy as they preemptively tried to
> predict and stop inflation. In other words the Fed caused every other
> post WW2 recession up to and with the exception of this one.
>
> Every time the Fed lowers rates, equity traders buy stock. This
> exaggerates volatility in the stock market. Young traders, and trading

> is a field dominated by youth, today have never experienced a market
in
> a true long wave economic down cycle rather than a Fed induced
> contraction.  Economic down cycles have never been stopped by
> monetary policy before. Greenspan's reputation had been built on
> postponing the business cycle by flooding the system with money to
feed
> a debt bubble.  There are two problems with that approach: 1) a day of

> rekoning can only be postponed but not avoided, and 2) debt is
> unsustainable without inflation and fatal with deflation.
>
> Driving down mortgage rates worked through 2002, but it has come to an

> end. It brought Greenspan time but nothing else.  The interest rate
> induced recovery will run out of steam by the thrid quater of 2003,
not
> withstanding the Fed optimistic pronouncement that the economy will
> recover by then.  What the Fed is really saying id that the economy
had
> better recover by then or we will all be in the soup.
>
> NEW YORK, Jul 15, 2003 (AP Online via COMTEX) -- Investors dumped
> Treasury bonds Tuesday, sending yields higher, after Federal Reserve
> Chairman Alan Greenspan indicated that the Fed would not buy back
bonds
> as a way to keep long-term interest rates low.
>
> Greenspan's remarks, which came in one of his twice-yearly economic
> reports to Congress, further disappointed bond investors following the
> Fed's smaller-than-expected interest rate cut in late June.
>
> Greenspan said he would likely use the Fed's main tool, cutting
> short-term interest rates, to stimulate the economy. That disappointed
> investors who hoped the Fed might buy back long-maturity bonds, which
> would increase their value.
>
> The price of the benchmark 10-year Treasury note fell 1 27/32 point,
or
> $18.44 per $1,000 in face value. Its yield, which moves in the
opposite
> direction, rose to 3.96 percent compared with 3.73 percent late
Monday.
>
> The 30-year Treasury bond fell 2 7/8 point to yield 4.95 percent, up
> from 4.77 percent a day earlier, according to Moneyline Telerate.
>
> The benchmark 2-year note fell 3/16 point to yield 1.45 percent, up
from
> 1.35 percent Monday. Intermediate maturities fell between 7/16 point
and
> 1 19/32 point.
>
> Yields on one-month Treasury bills were 0.89 percent as the discount
> rose 0.01 percentage point to 0.87 percent. Yields on three-month
> Treasury bills were 0.91 percent as the discount rose 0.03 percentage
> point to 0.89 percent. Six-month yields were 0.97 percent, as the
> discount rose 0.02 percentage point to 0.95 percent.
>
> Yields are the interest bonds pay by maturity, while the discount is
the
> interest at which they are sold.
>
> The federal funds rate, the interest on overnight loans between banks,
> rose to 1.19 percent from 1.06 percent late Monday.
>
> In the tax-exempt market, the Bond Buyer index of 40 actively traded
> municipal bonds fell 13/16 111 17/32. The average yield to maturity
rose
> to 4.97 percent from 4.90 percent.
>
> A single speech by Alan Greenspan may have squashed what remained of a
> tidal wave of mortgage refinancings that began three years ago.
>
> The Federal Reserve chief spooked the bond market Tuesday when, during
> his semiannual address to Congress, he said the central bank did not
> plan to buy bonds on the open market. The comments caused mortgage
> rates, which are tied to bond yields, to shoot up to their highest
> levels in three months.
>
> Within minutes after Greenspan completed his address Tuesday, lenders
> said they were besieged with telephone calls from anxious homeowners
> rushing to refinance before rates edged even higher.
>
> "My fear is that we may be seeing the last, dying gasp of the 'refi'
> boom," said Mark Ralston, senior loan officer at AccessOne Mortgage, a
> mortgage banking and brokerage firm based in Raleigh. "Most people
have
> already refinanced. And those who were on the fence are doing it now."
>
> And that could be bad news for the economy. Mortgage refinancings, in
> which borrowers trade one mortgage for another at a lower interest
rate,
> have funneled billions of dollars into consumers' pockets over the
past
> three years. Borrowers have used the extra cash to renovate their
homes,
> buy cars and pay for their children's college education.
>
> In mid-June, when the 30-year mortgage rate dipped to a 45-year low of
> 5.28 percent, lenders and mortgage brokers were overwhelmed with
> mortgage refinancing requests. Some lenders turned away potential
> business because they lacked the manpower to process the applications.
>
> "I've been in this business 20 years, and I have never seen anything
> like the amount of refinancings we saw in May and June," said David
> Novak, a loan officer at Home Mortgage Company of North Carolina in
> Cary. "It was almost out of control."
>
> Now mortgage lenders say this refinancing wave may have crested, in
the
> same way that stocks peaked in March 2000. And most blame Greenspan.
>
> About halfway through his address Tuesday, Greenspan said he saw no
> imminent need for the Federal Reserve to buy bonds on the open market.
> Earlier this year, the Fed had floated the idea of buying bonds, which
> would have driven interest rates even lower.
>
> When Greenspan pronounced that possibility "most unlikely," investors
> and Wall Street traders began dumping large numbers of bonds. That
> sell-off drove down bond prices and pushed up their yields, which move
> inversely to each other.
>
> Most lenders base mortgage loans on the 10-year bond's yield, which
> jumped 0.26 percentage points Tuesday to 3.983 percent -- the highest
> level since April.
>
> Greenspan tempered his comments Wednesday, when he finished his
> semiannual report to Congress, by saying that he has not ruled out
> buying bonds to stimulate the economy. Yet that did not reassure bond
> investors, as the yield on the 10-year bond remained high Wednesday at
> 3.92 percent.
>
> Normally, mortgage lenders issue one set of mortgage rates in the
> morning and leave them unchanged for the day. But within an hour after
> Greenspan's speech, banks began increasing their mortgage rates in
> response to the bond sell-off.
>
> By Wednesday afternoon, the average rate on a 30-year mortgage had
> jumped 22 basis points to 5.83 percent (a basis point is one-hundredth
> of a percentage point), according to Bankrate.com of North Palm Beach,
> Fla.
>
> The sharp increase caught some mortgage brokers off guard. Ralston of
> AccessOne said he had to call back some borrowers Tuesday afternoon
and
> tell them that the rate he quoted them in the morning was no longer
> accurate. In some cases, people who were considering plans to
refinance
> decided against it because of the rate increase.
>
> "There is a profound sense of lost opportunity among people who did
not
> refinance three or four weeks ago," said Greg McBride, senior analyst
at
> Bankrate.com.
>
> And the Fed's bullish comments on the economy suggest that mortgage
> rates will continue edging up, McBride said. Also Tuesday, the Fed
> released its semiannual report to Congress. In the report, the Fed
> predicted that the U.S. economy will grow 3.75 percent to 4.75 percent
> in 2004.
>
> When the economy is growing, investors tend to prefer stocks over
bonds.
> As demand for bonds falls, their yields rise -- pushing up mortgage
> rates.
>
> On 16 July 2003, the chairman of the US Federal Reserve delivered an
> optimistic growth forecast and bond traders reacted with heavy selling
> activity which sent yields at the long end of the curve soaring. Such
a
> reaction is not likely to be what Greenspan wanted, as low long-term
> bond rates help to determine mortgage and corporate lending rates, and
> can stimulate borrowing and spending. Traders, however, are wary of
> being trapped with portfolios heavy with relatively expensive
long-dated
> Treasury bonds when interest rates eventually rise.
>
> On 16 July 2003, Alan Greenspan, the chairman of the US Federal
Reserve,
> issued a surprisingly upbeat assessment of the US economy, and said
that
> the Reserve no longer felt it necessary to employ strategies such as
> buying back bonds to protect against deflation. Bond market traders
> responded with a global sell-off of long-dated bonds,
>
> Even though Federal Reserve Board Chairman Alan Greenspan told
Congress
> on Tuesday that he wants to keep interest rates low to help the
economy,
> bond investors had other ideas.
>
> The prices of long-term bonds plummeted -- and their yields soared --
> shortly after Greenspan implied the Fed probably won't need to buy
back
> long-term bonds to contain deflation.
>
> Higher yields on long-term bonds push up mortgage rates, and on
Tuesday,
> mortgage rates spiked up sharply. In the Bay Area, some 30-year fixed
> rate mortgages are now close to 6 percent, nearly a full percentage
> point from their lows in mid-June.
>
> If rates continue to climb, they will crimp borrowing and spending and
> weaken the fragile recovery -- the exact opposite of what Greenspan
> wants.
>
> However, investors were struck not just by Greenspan's words but by
his
> tone. His words still reflected the Fed's readiness to cut rates if
the
> economy looks weak -- but his tone showed more confidence that won't
be
> necessary.
>
> Only a few weeks ago, the Fed's main worry was on deflation, a
> destructive cycle of falling prices and wages that erode the economy's
> productive capacity. Not so much now, it appears.
>
> "What was very, very important in May became lip service in June and
is
> somewhat secondary now," said Gary Schlossberg, senior economist at
> Wells Capital Management in San Francisco.
>
> In addition, Greenspan gave a fairly optimistic forecast for growth,
> especially next year. Although he predicts the economy will expand at
a
> slow 2.5 percent to 2.75 percent this year, he thinks it will rebound
at
> 3.75 percent to 4.75 percent in 2004. If so, unemployment could drop
to
> 5.5 percent by the end of the year, he said.
>
> Again, what's good news for the economy would depress bond prices from
> the unusually high peaks now.
>
> The price of the benchmark 10-year Treasury note sank $18.44 per
$1,000
> in face value. Its yield, which moves in the opposite direction, rose
to
> 3.96 percent compared with 3.73 percent late Monday. The yield on the
> 30-year Treasury bond shot up to 4.95 percent on Tuesday from 4.77 the
> day before.
>
> That's a significant increase in yields from mid-June when the rate
for
> the 30-year Treasury bond was only 4.17 percent. But will rates
continue
> to rise or are they just bouncing up before they resume their downward
> trend?
>
> Gibbons Burke, the editor of markethistory.com, thinks a major change
in
> the bond market depends on whether the 30-year Treasury bond yield
rises
> above 5 percent -- roughly its level late last year and early this
year.
> If it does, then that will signal the end of declining rates, he said.
> If it doesn't, rates could continue to stay low or sink.
>
> "We're at the moment of truth," Burke said.
>
> Bonds fell after Greenspan indicated the Fed would be unlikely to
pursue
> unconventional tactics against deflation such as buying up long-term
> Treasuries, the Wall Street Journal reported.
>
> Greenspan said the Fed will hold short-term interest rates low "as
long
> as it takes" and may even cut interest rates further if necessary.
>
>
>
>
>