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Prime Rate

also known as the Fed, National, U.S. and WSJ Prime Rate

Monday, September 08, 2008

Futures Market 92% Certain Prime Rate Will Remain at 5.00% After September 16 Fed Meeting

The Federal National Mortgage Association (FNMA), a.k.a Fannie Mae, and the Federal Home Loan Mortgage Corporation (FHLMC), a.k.a Freddie Mac, are now under the conservatorship of the Federal Housing Finance Agency (FHFA). In other words, the U.S. government is now running both mortgage behemoths. The CEO's of both firms are being replaced with Wall Street veterans. Former Merrill Lynch vice chairman Herbert M. Allison will take the helm at Fannie Mae, while former US Bancorp chairman David M. Moffett will be the new boss at Freddie Mac.

How big are Fannie and Freddie? The two companies are associated with about half of America's $12 trillion mortgage market.

Nobody knows how much the bailout will cost American taxpayers, but estimates are in the tens of billions of dollars. Not a bad investment considering how important the two companies are to the well being of global financial markets. For some perspective, compare this estimate to the $12 billion per month price tag attached to the current Iraq war.

It's now abundantly clear that the government won't let the mortgage giants fail, so the mortgage-backed securities issued by Freddie and Fannie are now more attractive to investors on Wall Street. This will translate to cheaper fixed-rate mortgages for American home buyers. News of the government takeover was announced yesterday and, as a direct result, 30-year, fixed-rate mortgages got cheaper today.

The holders of Fannie and Freddie stock have not fared well since the two companies started to deteriorate:

  • On September 7, 2007, shares of Fannie Mae closed at $60.25 per share. Today, the stock lost 6.31 points (89.63%) to close at $0.73 per share.

  • On September 7, 2007, shares of Freddie Mac closed at $56.93 per share. Today, the stock lost 4.22 points (82.75%) to close at $0.88 per share.

Financial markets across the globe will cheer the takeover. Without a doubt, the Chinese government will breath a sigh of relief: 10% of China's GDP is invested in Fannie and Freddie.


As of right now, the investors who trade in fed funds futures at the Chicago Board of Trade have odds at 92% (as implied by current pricing on contracts) that the Federal Open Market Committee (FOMC) will vote to leave the benchmark Federal Funds Target Rate at the current 2.0% at the September 16TH, 2008 monetary policy meeting. 4% in the market are betting on a 25 basis point (0.25 percentage point) cut next week, while the remaining 4% are betting that the Fed will opt for a 25 basis point increase.

Summary of the Latest Prime Rate Forecast:

  • Current odds that the Prime Rate will remain at the current 5.0% after the September 16TH, 2008 FOMC monetary policy meeting: 92% (likely)

  • Current odds that the Prime Rate will remain at the current 5.0% after the October 29TH, 2008 FOMC monetary policy meeting: 87% (likely)

  • NB: U.S. Prime Rate = (The Federal Funds Target Rate + 3)

The odds related to federal-funds futures contracts -- widely accepted as the best predictor of where the FOMC will take the benchmark Fed Funds Target Rate -- are constantly changing, so stay tuned for the latest odds.

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