A year of steadily falling interest rates has proven stimulus enough to shield savings and loan shares from the recent meltdown on Wall Street. Analysts say the run could continue if the Fed makes good on pledges to keep the economy supplied with liquidity.

"I think they're a nice defensive play at this point, given the state of the economy," said Joy Palmer, analyst at Merrill Lynch. "People thought this mortgage cycle was going to end sooner than it appears to be. We've actually lengthened it out such that we don't have to worry about it for at least a quarter and maybe even six months."

The shares have been one of the few havens of the recent downturn.

Washington Mutual

(WM) - Get Report

, an industry bellwether, closed Wednesday at $37.24, up 10% since Jan. 3 and above its Sept. 10 close of $35.03. Another big thrift,

Golden West Financial

(GDW)

, trades for $57.80, down 11% for the year, but up from its Sept. 10 close of $54.68.

Thrifts, which lend money to home-buyers, have chalked up record earnings as a result of the Federal Reserve's dogged efforts to boost spending. Alan Greenspan and his central bankers have so far cut the fed funds rate eight times since Jan. 3. Some economists expect rates to fall as low as 2% by the end of the year.

On Tuesday,

Countrywide Credit

(CCR) - Get Report

reported a 64% spike in second-quarter earnings and raised its third-quarter estimates, citing strong demand for refinancing as a result of lower interest rates. Consumer mortgage fundings were $21.1 billion this quarter, up from $9.1 billion in the second quarter last year. Shares of the company closed Wednesday at $42.40, off its year high but about $2.60 above its Sept. 10 close.

"These are high quality companies at a time when other companies can't make sense of what earnings are," said Donald Coxe, chairman and chief strategist at Harris Investment Management. The strategist holds stocks in Washington Mutual and

Fannie Mae

(FNM)

, and considers them long-term investments.

Strong Demand

Analysts downplayed the risk of default in a faltering economy, saying even when other bills come due homeowners generally will find a way to make mortgage payments. "The last thing they'll stop paying for is their house," Paul Miller, analyst at Friedman, Billing, Ramsey. Asset quality also has been propped up by healthy real-estate prices. "It's also not like a decade ago when housing prices dropped and

people were thin on equity to begin with," Miller added. "It paid for them to walk away from their homes."

In a report released Tuesday, existing home sales rose 5.8% in August to a 5.5 million annual rate, while July home resales were revised up to a 5.20 million annual rate from an initial 5.17 million. August marked the first increase since May.

Analysts expect new purchases on mortgage loans to drop because of the lingering economic uncertainty. But Palmer estimated the purchasing market usually grows 8% to 10% a year, even during the recession in 1990, when many thrifts were crippled by loan defaults and poor balance sheets. "What you're seeing today is a much more consolidated

and well-capitalized industry," said Miller.

In addition, analysts believe the expected boom in refinancing could more than make up for the fall-off in new purchases. "Refinancing is still at very, very, healthy levels," said Palmer, noting that the "consensus on the street is that the Fed is not done easing."

End of the Cycle?

Thrift stocks saw their luster

dim in late August amid concerns the Fed was done easing. Mark Agah, analyst at Dain Rauscher Wessels, who downgraded Golden West Financial and

Downey Financial

(DSL) - Get Report

on Aug. 27, is standing by his downgrades, noting both are particularly dependent on adjustable-rate mortgages. "The larger originators of ARMS will have a tougher time growing earnings," Agah said, pointing out that others, like regional bank

Golden State

(G) - Get Report

, are less susceptible.

"The problem with thrifts is that the investing public thinks their earnings are highly dependent on the level of interest rates," said Miller, who said the earnings volatility of the sector is much lower than the overall earnings volatility of the S&P 500. While the stocks shot through the roof over the past year as interest rates fell, Miller believes the group, which traded between 15 and 18 times earnings in 1998, is now relatively undervalued.

Fair value is about 12 to 14 times earnings, Miller said, and "these things are trading under 10 times earnings. We think if you can pick up anything at 10 times earnings, especially with very solid earnings stream to boot, you're getting a deal." The analyst expects saving and loan stocks to experience more volatility "until the uncertainty of the situation goes away."

Coxe is also confident that thrifts and government-sponsored enterprises wouldn't see a significant drop in profits if the Fed were to stop lowering, or even started raising, interest rates next year. "They've demonstrated a tremendous ability to use derivatives to prevent

earnings from being impacted," said Coxe. "Among the many things I worry now about my portfolio, would I worry whether Fannie Mae's earnings will be impacted in the third quarter of next year? That's a luxury I'm not going to waste time on."