Homeowners cheer Fed's 'Operation Twist.' Wall Street, not so much.

The Federal Reserve announced Wednesday that it will drive down long-term interest rates through a strategy called 'Operation Twist.' The move has already pushed mortgage rates to historic lows, but Wall Street appears to have doubts about the plan's broader economic impact.

By , Staff writer

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    A trader works at the Chicago Mercantile Exchange's Chicago Board of Trade Wednesday. The Federal Reserve on Wednesday ramped up its aid to the beleaguered US economy, launching an effort called 'Operation Twist' to put more downward pressure on long-term interest rates and increase its support for housing.
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For the last several weeks, Holly Gustlin, a mortgage broker at Surety Financial, has been advising her clients not to lock in the interest rate on mortgages they were seeking.

The Sherman Oaks, Calif., woman told prospective borrowers the Federal Reserve would be acting to lower long term interest rates in the future so they should hold off.

On Wednesday, Ms. Gustlin was ecstatic – the Federal Reserve announced it would be selling $400 billion in short-term Treasury securities and reinvesting the money in long-term securities by next June in an effort to lower long-term rates, especially for mortgages. In the bond market, interest rates fell.

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“My clients are now saving up to a half a point in cost for the exact same interest rate simply by waiting till the afternoon,” says Gustlin.

For potential homeowners, the Fed’s new monetary policy move – nicknamed "Operation Twist," since it involves the Fed selling short-term securities to buy long-term bonds – is a boon. Almost immediately after the Fed’s announcement, the interest rates on mortgages dropped to historic lows.

However, for the larger economy it’s less clear if the Fed’s actions will get business revving up or consumers pulling out their credit cards. That may be one of the reasons why the Dow Jones Industrial Average fell 283.82 points, most of it after the Fed’s afternoon announcement.

The Federal Reserve itself characterized the economy as slow.

“Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated,” stated the Federal Reserve, which also said it anticipates the pace of the recovery will improve in the future. But, in a more ominous note, the Federal Reserve also said it detected “significant downside risks to the economic outlook, including strains in global financial markets.”

That may be one of the reasons why some Fed commentators felt the Fed’s actions may not have much impact, especially for consumers.

“I don’t think too many consumers think interest rates are too high,” says Dean Croushore, chairman of the economics department at the University of Richmond and a former economist at the Philadelphia Federal Reserve. “People ... just don’t want any more debt.”

His views are corroborated at the grass-roots level, where Thomas Fox, community outreach director at Cambridge Credit Counseling Corp. in Agawam, Mass., says people “have no appetite for debt.”

Mr. Fox says he counsels people that it is the right time to buy a house “if your financial house is in order.” Unfortunately, he says a lot of people can’t qualify for credit and won’t benefit from the lower interest rates.

However, it’s not just people paying down their credit cards. Many people are worried about another recession and possibly losing their jobs, says Greg McBride, a senior financial analyst at Bankrate.com in North Palm Beach, Fla.

“Many people lack the confidence to make the plunge into home ownership,” says Mr. McBride.

McBride says the bulk of the mortgage activity these days involves refinancings. “A lot have already refinanced at 5.25 percent and can do so again,” he says. For example, he calculates that someone who refinances a $200,000 loan from 5.25 percent to 4.25 percent on a 30-year, fixed-rate mortgage would save about $125 a month.

Some of the adjustable-rate mortgages are even lower, notes Erik Davidson, deputy chief investment officer at Wells Fargo Private Bank in San Francisco. He notes that a 15-year, adjustable-rate mortgage is now down to 3.25 percent, while a seven-year ARM (adjustable every year after that) is down to 2.75 percent.

“The problem is that people with a 7 percent or 8 percent mortgage don’t qualify because either their loan-to-value ratio is too high or their credit scores too low or they don’t have sufficient income, assuming they have a job.”

However, Laura Gonzalez, an assistant professor of finance at Fordham University, hopes the Federal Reserve program provides individuals and corporations with a sense of confidence. “We don’t have a financial crisis but a confidence crisis,” she says.

The Fed’s policy may also be designed to force individuals to take on more risk. Mr. Davidson of Wells Fargo observes that money market funds are now paying about 0.5 percent per year. At that rate, he calculates, it would take 1,440 years to double your money.

“Maybe the Fed is thinking, ‘Let’s make it so painful for people to hold cash they have to do something else with the money,” he says.

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