WHEN THE FED´S BUYING BINGE ENDS / THE WALL STREET JOURNAL

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SEPTEMBER 23, 2009, 5:03 P.M. ET

When the Fed's Buying Binge Ends

By PETER EAVIS

The Federal Reserve on Wednesday acknowledged -- but didn't answer -- the question that is on everyone's mind: What happens when it stops buying hundreds of billions of dollars in financial assets?

In its monetary-policy statement, the Fed said it would "gradually slow the pace of these purchases in order to promote a smooth transition in markets." Suddenly cutting to zero, presumably, could prove too much of a jolt.

But even a gradual pullback could have big repercussions. Zero-percent interest rates and Fed purchases -- financed by printing money -- have played a massive role in reviving stocks and bonds and rekindling the economy.

So far, the Fed's net buying of mortgage-backed securities totals nearly $850 billion, or about 80% of securities issued this year by entities like Fannie Mae and Freddie Mac.

Since these agencies bought nearly all new mortgages made this year, the central bank has effectively acquired most of the home loans made in the U.S. That has helped soften the decline in house prices and sparked a refinancing boom that has boosted spending power for many households.

What happens after that program expires? The Fed has tentatively extended it by three months to the end of March 2010.

Mortgage rates will likely move up, as private-market buyers will charge more than the Fed for bearing the risks of holding government-backed mortgage securities. As the Fed pulls back, Credit Suisse expects mortgage securities will yield about 1.15 percentage points more than 10-year Treasurys, compared with 0.9 percentage point now. Granted, that isn't a big increase, but there is huge uncertainty given how much of the market is dominated by the Fed. Any sustained upward move in mortgage yields could delay a housing recovery given its shaky state.

Meanwhile, the Fed hasn't been buying corporate bonds, but its purchases of mortgages and Treasurys likely helped a blistering recovery in that market. Private investors were more likely to buy corporate debt than mortgages and Treasurys, once Fed buying made yields on those unattractively low. On a net basis, U.S. investment-grade companies will issue an estimated $820 billion of bonds this year, almost as much as in the previous three years combined, according to Barclays Capital.

A risk is that investors will be less attracted to corporate debt if mortgage yields go up as the Fed pulls back. Of course, the Fed could simply extend its asset purchases if private investors get the jitters again -- something it hinted at Wednesday, saying it will "evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets."

That is, if markets play along. Investors are already balking at the heavy use of printing presses. Just look at the sliding dollar.

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