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Wall Street Whispers: Cheap Money Ain't Working

News out of the Federal Reserve and Freddie Mac this week provide ample evidence that cheap money is doing little good for the U.S. economy.



) -- The

Federal Reserve's

policy statement this week, along with a report from

Freddie Mac


, provide ample evidence that cheap money is doing little good for the U.S. economy.

The reason is simple - not enough people can take advantage of that cheap money - but the solution to the problem will not be quite as easy.

On Tuesday, the Fed indicated that it will continue to hold its key interest-rate target at the lowest possible level of 0% to 0.25%. It will take the extra step of reinvesting interest into the capital markets to stimulate growth.

Meanwhile, on Wednesday, Freddie Mac captured the Fed's policy conundrum perfectly: It expects mortgage rates to hit new historic lows, but it doesn't guarantee that this woo buyers into new purchases.

"Whether on-the-fence homebuyers and potential refinancers will soon take advantage of the historic opportunities presented by the lowest mortgage rates in five decades remains to be seen, but we're not counting on a change anytime soon," the mortgage-finance giant said in an economic outlook statement titled "Where Have All the Originations Gone?"

Consumers who drive the U.S. economy don't need wooing; many would like to take advantage of the low-interest rate environment. But they can't because so many other things stand in the way.

Freddie Mac detailed some of the vast problems plaguing the mortgage market. There are the "underwater" homeowners who owe more than the home is worth. There are the jobless who have seen credit quality decline too much to qualify for a loan. There are those with home-equity loans that stand in the way of first-lien refinancing plans.

Those homeowners have seen mortgage rates hit fresh lows in recent weeks, with traditional 30-year fixed mortgages now averaging 4.5%. Those rates have stayed at, or below, 5% since early May and have remained consistently flat for the past eight weeks.

"Looking ahead, fixed-rate mortgage rates may edge down further," said Freddie Mac, "though we think it unlikely that they would fall far from where they are today. But it is also unlikely that they will rise quickly, especially given the low yields on the 10-year Treasury note, the benign inflation environment (importantly, low expectations of future inflation), and the still-weak employment picture."

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few people are betting

that rates will go up soon or surge quickly when they do. It's a sharp turnaround in sentiment from early spring, but reflects the depth of the economic crisis the country is still struggling to climb out of.

Still, the low-rate environment has done some good for the select few who can take advantage.

Refinancing makes up the vast majority of mortgage activity these days, helping borrowers whose finances are still in decent shape. Additionally, the large portion of all-cash transactions shows that those who saved enough money during the housing bubble are capitalizing on rock-bottom home prices. About 25% of existing home sales have been paid in cash this year, vs. 5% to 10% in more "normal" times, according to industry data from the National Association of Realtors.

A larger portion of those refinancing are paying down principal balances in cash as well. It serves as a way to get the cheapest mortgage rate, and paying down debt seems more attractive to some when investments aren't yielding much anyway.

But if the market's reaction to the Fed statement on Tuesday is any indication, the government will have to do much more to spur economic growth. The Dow Jones Industrial Average dropped marginally on Tuesday, with commentators citing Fed-related economic concerns, followed by declines in overseas markets and additional bearishness on Wednesday. By late afternoon, the Dow had already fallen more than 200 points.

Funneling cheap money into the system worked at one time - at the height of the crisis when bank balance sheets were constrained. As a result, the country's largest banks -

Bank of America

(BAC) - Get Bank of America Corporation Report


JPMorgan Chase

(JPM) - Get JP Morgan Chase & Co. Report



(C) - Get Citigroup Inc. Report


Wells Fargo

(WFC) - Get Wells Fargo & Company Report


Goldman Sachs

(GS) - Get Goldman Sachs Group Inc. (The) Report


Morgan Stanley

(MS) - Get Morgan Stanley Report

- moved quickly from beat-up bailout cases to solid franchises with booming profits.

Now, the specter of deflation is threatening banks' hedging strategies and stands to hurt consumers as well. The solutions for today's problems may be more difficult to structure than earlier quantitative easing plans, and will be harder to swallow politically.

"There are some long-term inefficiencies in the U.S. economy that are not going to get solved with 0% interest rates," says Michael Bechara, managing director of Granite Consulting Group, who consults with banks on risk management and financial issues. "The only way to get rid of this debt is to pay it off or to default on it."

-- Written by Lauren Tara LaCapra in New York


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