Housing Legislation a Help but No Magic Wand

 
 
By Reuters -  |  Posted 2008-07-24
 
 
 

NEW YORK (Reuters) - Washington's plan to rescue the housing market may help shore up the U.S. economy as it copes with the worst slump in the housing market since the Great Depression, but don't look for a swift recovery.

Investor confidence has been bolstered by the government's recent proposals, driving stock price higher since last week, and economists agree the move to provide extra funding for mortgage giants Fannie Mae and Freddie Mac is vital.

One unintended consequence, however, has been rising interest rates as the bond market has sold off sharply since the plan was unveiled last week. That risks muting, at least in part, the broader benefit of supporting the two mortgage finance firms.

The U.S. House of Representatives approved the housing plan on Wednesday afternoon, with the Senate expected to vote on it later.

Policy-makers and economists see the government sponsored enterprises as crucial to keeping the housing market open for business since they own or have guaranteed almost half of the $12 trillion in U.S. mortgage debt outstanding.

Financial markets' recent loss of confidence in the GSEs led many economists to contemplate the consequences if they were to collapse, convincing many that measures being taken by Congress were necessary.

"It's necessary and it will have positive benefits to the U.S. economy for a period while we're in such difficult straits," Brian Fabbri, managing director of economic research at BNP Paribas, said about the rescue package, which has also been supported by the U.S. Treasury.

"If there is no GSE Treasury help, the housing market wouldn't just be in recession or declining, it would plunge. We wouldn't begin to estimate how low it might go if GSEs were not able to fulfill their mission."

MOUNTING COSTS

President George W. Bush on Wednesday dropped a threat to veto the rescue bill, seeing the need to promptly address the housing and credit crisis as more important than his earlier reservations about a provision in the bill unrelated to the GSE aid.

Removal of the presidential veto threat spurred investors on Wednesday to snap up shares and bonds of Fannie Mae and Freddie Mac which are privately held companies despite their government-sponsored status.

The prospects of GSE rescue had a positive influence on stocks on Wall Street. However it contributed to a sell-off in safe-haven government bonds, causing their yields to rise.

Government bonds were also weighed down by concerns over the cost of the measures to shore up Fannie and Freddie, which could potentially amount to $25 billion, according to congressional budget analysts.

The measures would give beleaguered Fannie Mae and Freddie Mac access to an expanded credit line from the U.S. Treasury. In addition, it authorizes the Treasury to purchase equity in the two companies if necessary.

If sustained, the rise in Treasury yields could ultimately hurt the housing market, since government bonds are the benchmark for borrowing costs throughout the economy.

Interest rates will remain a key focus for the housing market's recovery. Thirty-year mortgage rates hit one-year highs last week, eroding demand for U.S. home loan applications, according to data from the Mortgage Bankers Association released on Wednesday.

Economists will continue watching mortgage rates but said the mild rise in Treasury yields so far was a small price to pay for the goal of financial stability that is the rationale behind the bill.

Given Treasuries' status as ultra-safe investments, it is also a good sign for the economy that their appeal is in decline, some argue.

"Anything that stabilizes the financial system at this juncture is probably a contributor to better outcomes on growth," said Neal Soss, chief economist at Credit Suisse in New York.

Still, economists caution against getting too optimistic over the legislation. The housing market has been in a steep slide for nearly three years, during which time a glut of homes for sale has swelled, ruling out any quick fixes from the current rescue plan or other sources.

"What the government does is help to draw a line in the sand and say we're not going to allow a major collapse here akin to what we saw in the Great Depression," said Brian Levitt, economist at OppenheimerFunds in New York.

"But there's simply not a lot of stimulus for the broad economy and there's not a lot of stimulus particularly for the housing market."

(Reporting by Burton Frierson )