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Editorial: Rate Cut Has Risks

The mortgage industry largely cheered the Federal Reserve Board's decision to cut the fed funds rate by 50 basis points recently, judging that it will help to limit the depth of the housing downturn by making home loans more affordable.

But as with many things in the economy, the rate cut comes with a number of potential unintended consequences, some of which could hit mortgage servicers hard.

While we applaud the rate cut, we also hope it doesn't signal a weakening of the Fed's commitment to keep inflationary threats contained. Wall Street applauded the 50 basis point move, but some skeptics thought a more incremental 25 basis point move would have been more prudent.

So far, in the early weeks since the Fed's cut, the move seems to be working. Stock prices rose on the news and long-term mortgage rates have dipped to their lowest level in months. The national average rate on 30-year fixed-rate mortgages had remained below 6.5% for six straight weeks as MSN went to press. That's not low enough to spark a refinancing boom and accelerate portfolio churning, but it does help borrowers with adjustable-rate mortgages facing potentially burdensome rate adjustments to finance into more attractive fixed-rate loans.

That, at least in the design of economic policy makers, may alleviate some of the home loan defaults that could result from rate resets.

In addition, by keeping home loans at affordable levels, the rate cut may serve as a buoy to keep home prices from dipping much lower than they already have. That's good news for servicers who see their foreclosure workload climbing and want to be able to sell REO as quickly as possible.

Now for the downside. Suppose the rate cut doesn't stimulate the economy or prevent the home loan slide from pushing the economy into recession? A recession, though we think unlikely, would be accompanied by another slide in long-term rates, and that could spark the kind of refinancing binge that reduces the value of mortgage servicing rights.

More worrisome, many think, is that the rate cut could lead to higher-than-anticipated inflation down the road. (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com/ http://www.sourcemedia.com/

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