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Fed's Liquidity Rain Dance May Reduce CRE Loan Rates

Commercial real estate investors should see lending rates drop heading into 2008 thanks to a triple play of actions by the Federal Reserve this week intended to stimulate lending and inject credit into the economy.

Few market observers were surprised on Dec. 11 when the Federal Open Market Committee lowered its target for the Fed funds rate, which banks use to calculate overnight interest, by a quarter point to 4.25%. The Fed didn’t stop there, however, and also reduced its target for the discount rate, which the Fed charges on loans to banks, by 25 basis points to 4.75%.

The real surprise came on Dec. 12, when the Fed trumped the previous day’s announcements by unveiling an international effort by central banks to ease a liquidity crunch in global financial markets. A series of credit auctions by the Federal Reserve will make dollars more readily available to banks, and on a wider range of collateral including residential mortgage-backed securities.

“The goal of all of the steps taken by the Fed is to ease shorter-term credit availability, and you need to look at all of these actions in concert,” says Jamie Woodwell, senior director of commercial/multifamily research at the Mortgage Bankers Association.

So far, this week’s liquidity news brought a downward change in key lending indexes. The one-month London Interbank Offered Rate (LIBOR), a basis for many adjustable commercial real estate loans, fell to 5.03% at midday today from 5.10% on Tuesday. Even Tuesday’s close marked a drop from 5.35% just before the central banks’ announcement.

“For investors, to the degree this affects LIBOR or other indices that some commercial loans are priced to, this can impact the rates that borrowers will pay,” Woodwell says.

European markets were already closed when the Fed released its Dec. 11 statement on rate cuts, so the Fed held back news of the international initiative until the following day when all the markets were open and could participate in the joint announcement. The Fed has established a new credit auction facility that will conduct its first auction on Dec. 17, lending $20 billion to the bank bidding the highest interest rate. Another $20 billion auction is set for Dec. 20, with auctions for yet-to-be-determined amounts of credit slated for Jan. 14 and 28.

The Fed also announced temporary currency swap arrangements with the European Central Bank and the Swiss National Bank to auction $24 billion to banks in Europe, where dollar-denominated capital is hard to come by. Other central banks, including those in England and Canada, eased restrictions to allow a wider spectrum of collateral and stimulate lending.

Why is the Fed going above and beyond its regular channels of guiding the market through the Fed funds rate? The adage that desperate times call for desperate measures sums it up best. The economy is clearly slowing despite cuts in the Fed funds rate of a quarter-point on Oct. 31 and a half-point on Sept. 18. This past Friday, the Bureau of Labor Statistics reported November’s non-farm employment increased by just 94,000 jobs, well below the 12-month average gain of 127,000 per month.

Some economists are unconvinced the Fed’s actions will provide enough incentive to overcome lenders’ unwillingness to lend money in an uncertain economic environment. Bill Dunkelberg, chief economist for the National Federation of Independent Business, believes any small reductions in benchmarks such as LIBOR or the Fed funds rate will be overpowered by increasing risk spreads, which lenders add to base rates to determine interest. In other words, the borrower’s cost of capital will go up despite falling Treasury rates, for example. As Dunkelberg sees it, “on the street we’ll be paying more for the money even though the Fed is cutting rates.”

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