December 1, 2008 - Federal Reserve, Washington D.C.

The Federal Reserve's plan to spend $600 billion buying mortgages is driving down lending rates and boosting home affordability, which combined with decreasing inventories may signal a 2009 recovery for the battered home-building sector, some Wall Street analysts say.

The Fed's announcement last week pushed rates on 30-year fixed-rate mortgages below 6% as panic-stricken lending markets eased somewhat after news of the government's latest efforts to inject liquidity into the financial system.

The recent decline in mortgage rates, primarily resulting from the recently-announced Term Asset-Backed Securities Loan Facility (TALF), has led to a significant improvement in affordability, and over time better affordability typically leads to an improvement in sales activity," wrote Credit Suisse analysts, led by Daniel Oppenheim, in a research note Monday.

For example, Credit Suisse said a percentage-point decline in mortgage rates has the same impact on affordability as a 10% decline in housing prices. However, it said changes in affordability often take nine months to a year to result in improving home sales.

"In addition, the lower mortgage rates and better affordability may also help to limit the decline in home prices," they said.

Under TALF, the Fed plans to buy up to $500 billion of mortgage-backed securities issued by Fannie Mae, Freddie Mac and other government-sponsored enterprises, as well as $100 billion of debt.

Mortgage rates immediately dropped by more than half a percentage point, according to some rate surveys, in the wake of the Fed's efforts to help troubled homeowners and get the housing market back on its feet. Lower rates help borrowers seeking to refinance and make new homes more affordable as a result of smaller monthly payments.

Mortgage rates and affordability

Credit Suisse estimated that the mortgage payment on the median-price home now represents 16.7% of median household income, down from 21% this past summer, with most of the decline taking place last week after TALF was unveiled.

That's well below the long-term average of 23% from 1981 to 2007, and housing is the most affordable it's been since February 1994 when the mortgage on the median-price home equated to 18% of the median income.

"Importantly, affordability is also returning to attractive levels in key building markets," the analysts said.

"We do not expect a snap-back in sales activity given the negative consumer sentiment toward housing as of late, as consumers are nervous about spending money on what is now generally viewed as a depreciating asset," they wrote. "However, we expect that this improved affordability will help and will likely lead to at least a bottoming of sales in 2009."

After a historic boom in home prices fueled in large part by easy credit, the U.S. residential housing market is caught in the grips of one of the worst downturns in recent memory. There is an enormous overhang of unsold homes on the market that could rise further if foreclosures spike.

Buyers lacking pristine credit scores have had difficulty getting loans, while worries about the health of the overall economy have dampened sentiment. However, falling home prices and lower mortgage rates could finally entice wary buyers.

With some foreclosures selling at rock-bottom prices, Credit Suisse had anticipated an incremental 15% further decline in home prices over the next year, but said the drop-off in mortgage rates could limit the damage.

"We have also seen some signs of stabilization on foreclosure pricing in several of the hard-hit markets as of late, which may indicate a bottom in home prices in those areas," the analysts said.

Original Story - Wall Street Market Watch