Fed swap may help economy, but slowly

From Little Fork to Luverne, Minnesota home buyers find mortgages harder to come by. Hospital chains cope with soaring interest costs on their debt. Twin Cities-area companies write down millions on investments. Lenders pass along higher costs to many student borrowers.

They're the collateral damage from U.S. financial market tremors that have spread from subprime mortgages to corporate debt over the last year.

There's not likely much immediate relief in a Federal Reserve plan to calm credit markets with a temporary $200 billion swap of U.S. Treasury bonds for private IOUs in the subprime mortgage market, experts say. To many, the end to the current troubles may be months away, and some believe the ultimate solution will be a bailout that could demand $600 billion to $800 billion from taxpayers.

The Fed last week offered to lend major banks $200 billion by swapping Treasuries for a like amount of mortgage-based securities for 28 days -- offering banks an easy-to-sell asset in return for securities nobody wants to buy at the moment.

"Now they can borrow against them rather than sell at a fire-sale price in the market," said Keith Hembre, chief economist at FAF Advisors, an arm of U.S. Bancorp. "It's beneficial, but kind of at the margin at this point."

Jim Paulsen, chief investment strategist at Wells Capital Management in Minneapolis, called the Fed move "an odd solution to an odd problem."

"It's a good try. Will it work?" he asked. "Ultimately, I don't think so."

The larger issue is that restoring investor confidence is a complex, multilayered process, just as it took time and the coming together of a variety of factors to derail that confidence in the first place.

"If it's accurate to call this a panic, I'm not sure you can un-panic the market in 28 days," said Kenneth Goldstein, senior economist at the Conference Board, a New York City-based business research firm.

Goldstein thinks the latest Fed effort holds more promise than its previous moves, which were confined largely to reducing interest rates. But he argues that the federal government will have to raise the ante on aid substantially and turn to an outright bailout of mortgage and other financial markets in the range of $600 billion to $800 billion.

The Fed will show its hand again Tuesday, when its Open Market Committee meets. Economists foresee the Fed cutting a half-point to a full point from its the federal funds rate, a key short-term interest rate that serves as the basis for many home equity, auto and credit-card rates. That rate now is 3 percent.

That benchmark percent rate is 2.25 percent lower than it was in August, when the financial crisis first bloomed. Yet many companies and people are finding their debt burdens harder to carry and financing harder to find now than it was then.

NorthStar Education Finance, based in St. Paul, last month told student borrowers that it was suspending a "repayment bonus" that in the past 16 months had saved students nearly $18 million. It blamed a sharp rise in credit costs.

Park Nicollet Health Services last month reported that failed auctions on outstanding debts could drain $23 million a year from its coffers if the debt markets remained in gridlock. Fairview Health Services was struggling to avoid the same fate. Neither responded to calls for comment last week on their financial situations.

Even companies with top credit ratings are finding their bonds going begging, said Si Matthies, Wells Fargo's head of trading/institutional brokerage and sales.

"There are thousands of Triple A credits trading at 70 cents on the dollar," Matthies said.

Confidence undermined

In part, that's because investors discovered that the finances of some Triple A companies were more shaky than solid, undermining faith in credit ratings, he said. Another factor at play is that an investor buying a bond at 70 cents on the dollar gets a bargain only if the bond doesn't end up trading at 60 cents or 50 cents days or weeks from now.

"Players in the market now are really being very careful," Matthies said. "There's a lot cash piled up in the short end."

But Goldstein at the Conference Board believes greed will overshadow fear before the year is out, if not sooner. First, the Fed, and market conditions, will have to convince market players that the value of homes -- and the bonds that finance mortgages and other debts -- has bottomed out.

"By some measures, we might be looking at the loss of $4 trillion in [housing and financial] assets," Goldstein said. "That sounds like a big number. Back in the tech wreck, we lost $6 trillion."

The tech bubble bursting was followed by a short, mild recession.

In the months ahead, Goldstein foresees a federal bailout similar to the creation of Resolution Trust Corp. that ended the savings and loan financial crisis in the early 1990s.

The government ended up buying everything from homes to hotel resorts -- pumping money into credit markets -- and ultimately made a profit selling properties as the real estate market improved.

A similar strategy should work in 2008, Goldstein said.

"It's hard to maintain a panic when you've got a lender of last resort that's ready to act in showing they're willing to put their money -- our money -- where their mouths are," he said.

Mike Meyers • 612-673-1746