Fed's action: The kindest cut?

Band-Aid or cure?

The Federal Reserve's decision Tuesday to cut the federal funds rate a half percentage point won't provide a long-term fix for the sagging housing market, but it could result in cheaper adjustable-rate mortgages, increased liquidity and a psychological boost.

Will that be enough to spark a turnaround in the market?

"It's a good sign, but I'm not sure it will make a ton of movement," said Bob Peltier, president of Edina Realty.

That may be because rates on long-term mortgages -- the kind that most people use when they buy a house -- aren't heavily influenced by the federal funds rate. Furthermore, the markets have already factored in Tuesday's rate cut -- the first in four years.

Still, because the Fed's action will cut the cost of short-term borrowing on some credit cards, home-equity loans and other consumer credit, homeowners might feel a little less financial pressure, and that could boost consumer confidence.

Meanwhile, in an attempt to jump-start home sales, Edina Realty is offering a one-year, one-percentage point discount on FHA and VA mortgages originated through the company. The promotion is the third of its kind by the company in 18 months.

Mortgage rates near lows

In recent weeks mortgage rates have fallen to within a percentage point of the all-time lows that helped push home sales and prices to record highs nearly three years ago.

The benchmark 10-year Treasury yield, which generally runs parallel to fixed-rate mortgages, fell from 5.19 percent during the first week of July to 4.38 percent a week ago. "You'd have to go back to early 2006 to find a similar environment for the 10-year Treasury," said Michael Swanson, vice president and senior economist with Wells Fargo in Minneapolis.

The Fed funds rate is more closely tied to the price of adjustable-rate mortgages (ARMs), which in recent months have fallen from grace among home buyers who are leery of their sometimes painful rate adjustments.

While Tuesday's announcement won't wipe away future rate increases for people with adjustable-rate mortgages, it could reduce their size.

"The payment still increases, but that difference is very significant to homeowners wondering how they're going to handle a payment increase," said Greg McBride of Bankrate.com.

Until two years ago, most borrowers favored ARMs even though fixed-rate loans were only marginally higher and offered more long-term security.

Today, a growing number of borrowers are shifting to long-term fixed rates even though introductory rates on short-term adjustables have fallen relatively dramatically in recent weeks.

More Fed rate cuts may lie ahead. Investors in the Chicago Board of Trade fed futures market are betting that the rate will fall to 4.25 percent in May 2008.

That could be good news for people who are trying to refinance out of their mortgages or who are worried the market hasn't hit bottom yet as a liquidity crisis on Wall Street makes access to credit more difficult.

The Fed's action comes at a critical time in the housing market as homeowners watch some of the price gains they've made in recent years slip away.

Though inventories of unsold homes have risen to record levels nationally and in Minnesota and prices have fallen only modestly, the fundamentals of the real estate market are still strong.

In addition to low mortgage rates, unemployment rates are still relatively low and, looking at the flip side of high inventories, buyers have more choices than they've had in decades.

Time for adjustment

McBride said that, while the Fed's action is a welcome development, there are two hurdles the housing market has to clear: high home prices and too many unsold homes.

"Fed rate cuts do not solve either problem," he said. "The passage of time will, but the Fed will not, nor are they trying to."

Some market watchers say that the best remedy for the housing market might simply be time for buyers and sellers to adjust to new conditions. And that's why the Fed's action Tuesday could provide reassurance and a much-needed boost.

"It establishes that the housing market is not in free fall," said Swanson. "The market is psychological; if the Fed is riding to the rescue again, then there will speculative demand and people sitting on the sidelines saying, 'This will be a better market.'"

Jim Buchta • 612-673-7376

Jim Buchta • jbuchta@startribune.com