THE BASIS POINT

FOMC Cuts Fed Funds To 0-0.25%, Discount Rate To 0.5%, Reiterates Massive Mortgage Rate Support

Below is the full statement from the Federal Open Market Committee from their final meeting of 2008. They cut the overnight bank-to-bank Fed Funds Rate to a target range of 0 to .25% and cut the Fed-to-bank Discount Rate to 0.5%. They also reiterated their commitment to purchase up to $500b in mortgage bonds in the coming months—this is known as “quantitative rate easing,” when traditional short-terms rate cuts don’t work to bring mortgage rates down, the massive buying of mortgage bonds pushes mortgage bond prices up and yields (or rates) down.

The only mortgages that are directly tied to the Fed Funds Rate are Home Equity Line of Credit mortgages. These are base on the Prime Rate which is Fed Funds+3%. So today, Prime is now 3.25%. All other mortgages up to $625,500 follow mortgage bond trading. So when the Fed starts buying mortgage bonds, the rates on those loans are likely to drop further. Rates for mortgages above $625,500 are set by individual lenders because the market for packaging these loans into bonds is dead right now—so these rates are not dependent on mortgage bond pricing like the sub-$625k loans.

FULL FED STATEMENT
The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.

Since the Committee’s last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably. In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

The focus of the Committee’s policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco. The Board also established interest rates on required and excess reserve balances of 1/4 percent.