Revised loans to get U.S. backing

Reynolds and Puzzanghera are Times staff writers.

Federal officials moved closer Wednesday to guaranteeing as much as $500 billion in mortgages after they are modified to make them more affordable to homeowners, part of the multifront battle to resuscitate the country’s flagging economy.

The idea, outlined last week by Federal Deposit Insurance Corp. Chairwoman Sheila C. Bair, is to help millions of families stave off foreclosure by offering loan guarantees and other enhancements to encourage lenders to change the terms of troubled home loans, thus lowering monthly payments.

Also Wednesday, the Federal Reserve, as expected, cut its benchmark lending rate to 1%, matching the lowest level in four years. But economists and financial analysts doubted that the move would prevent a potentially long and deep recession.

The depth of the country’s economic distress could become evident as soon as today, when the government releases its first estimate of third-quarter growth -- or, more likely, contraction -- in the economy.


Most economists are expecting a negative number, which would tend to confirm the consensus view that the economy already is in a recession.

The FDIC’s plan to stave off the avalanche of foreclosures would be authorized under the $700-billion financial rescue package passed by Congress and would cost the government an estimated $40 billion to $50 billion.

The agency is trying to prod banks and other lenders to do what regulators have been asking them to do all along -- restructure loans. That could include such changes as lowering the interest rate, reducing the principal or lengthening the term of loans.

The proposed loan modifications are similar to those being implemented by Bank of America Corp.'s Countrywide unit, based in Calabasas, and by the FDIC for mortgages serviced by failed IndyMac Bank in Pasadena.

Details were still being worked out, and it was not clear how quickly the program would be unveiled, though pressure for action to help homeowners has grown since the approval of a succession of multibillion-dollar measures to aid financial institutions.

On the interest-rate front, the Fed dropped its benchmark federal funds rate -- the rate banks charge one another for overnight loans -- by half a percentage point, to 1%, only three weeks after a previous half-point cut.

Though analysts doubted the move would help the economy much, they praised it as a sign of the Fed’s intention to act aggressively to stem the damage to the economy.

“Once credit starts to flow more freely, the lower rates will help” stimulate the economy, said Gus Faucher, economist with Moody’s


“We can’t escape things getting worse before they get better,” said Diane Swonk, chief economist at Mesirow Financial in Chicago. “But we can prevent widespread hemorrhaging, and that’s what the Fed is doing.”

John Silvia, chief economist at Wachovia Economics Group, estimated that the country’s gross domestic product -- a measure of total output of goods and services -- fell at a 1% rate in the third quarter and would drop at a rate of as much as 3% in the fourth quarter.

One common definition of a recession is two or more consecutive quarters of contraction in the GDP.

“The weak economy is still going to be the story going into December,” Silvia said. “The consumer is really going to get hit in the fourth quarter.”


The stock market had little reaction to the widely expected rate cut.

The Dow Jones industrial average, which soared 889 points Tuesday, was up as much as 145 points Wednesday before the Fed’s decision. The index initially fell after the announcement, then bounced up and down before closing at 8990, a loss of 74.16 points.

“At the end of the day, the fact that we didn’t take a lot off of yesterday is the best we could hope for,” Swonk said.

The Fed’s cut spurred gains in Asian stock markets, with Hong Kong’s blue-chip Hang Seng Index rising nearly 10% in afternoon trading and Japan’s Nikkei 225 stock average gaining 7%.


Chinese stocks gained after China cut its benchmark lending rate 0.27 percentage point, its third cut in two months, to try to halt the sharp fall in the nation’s economy.

The Federal Reserve, in announcing its rate cut, said “recent policy actions, including today’s rate reduction . . . should help over time to improve credit conditions and promote a return to moderate economic growth.”

David M. Jones, a former Fed economist and president of DMJ Economic Advisors in Denver, interpreted that as a signal that the Fed intended to keep its key rate at 1%.

“It looks like the Fed is not going to go any lower, and that’s why the stock market response is somewhat muted,” Jones said.


But Swonk, noting that the Fed downplayed inflation compared with “downside risks to growth,” said the central bank had left the door open to further cuts.

“It’s wide open,” Swonk said. “Zero percent is the boundary, not 1%. . . . This is a Fed that’s more than prepared to do what it needs to do.”

At 1%, the Fed’s benchmark rate matches its level from mid-2003 to mid-2004. Some economists have said that such a long time at such a low rate fueled the housing bubble that inevitably deflated and set off the mortgage meltdown that resulted in the current financial crisis.

In 2004 the Fed began slowly ratcheting the rate up until it crested at 5.25% in June 2006, as the housing market peaked.


In September 2007, as home-loan defaults mounted, the Fed began to lower the rate, slashing it in fairly steep increments until it reached 2% in April.

But the effect of the cuts was limited because the credit crunch was keeping banks in many cases from lending at any price.

So, instead of just opening the money spigot, the Fed broke new regulatory ground by targeting streams of cash at specific trouble spots.

Soon after the failure of Bear Stearns Cos. in March, the Fed began lending to investment banks as well as conventional banks. This month the central bank said it would start buying commercial paper -- short-term IOUs that companies issue to help finance daily operations.


But, though the credit markets are showing signs of thawing, the overall economy is increasingly causing concern. In response, the Fed, acting between its scheduled meetings, slashed its key rate by half a point on Oct. 8.

Wednesday’s cut means the rate has dropped a full percentage point in less than a month.

Faucher of Moody’s said that keeping rates at such a low level could spur inflation over time, but would pose a concern only after the economy picked up again.

“Inflation is something that we should be worried about a year from now, but not right now,” Faucher said.


In addition to lowering the target for its federal funds rate, the Fed dropped the rate it charges directly to banks. The so-called discount rate was lowered by half a percentage point as well, settling at 1.25%.

On the mortgage aid plan, FDIC spokesman Andrew Gray said the agency had had “productive conversations” with Treasury Department and other Bush administration officials. He said it was too early to speculate about the framework or size of such a potential program.

Treasury spokeswoman Jennifer Zuccarelli said the Bush administration was “looking at ways to reduce foreclosures, and that process is ongoing. We have not decided on a particular approach.”