The Fed said it would buy up to $100 billion in debt issued by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.  It also said that it would buy up to $500 billion in mortgage-backed securities backed by Fannie Mae, Freddie Mac, and Ginnie Mae ("the GSEs").

This is huge for the housing market. While the rates of Treasuries have fallen to historically low levels in a massive flight to quality, the paper issued by the GSEs have stubbornly refused to rally, and continue to trade at wide premiums.  The market was buying 10-year Treasuries at a yield of 3% and bypassing 10-Year government guaranteed FNMAs at 4.5%.  Why?  Because there was a perception the government guarantee wasn't ironclad.

Now the Fed will buy the GSE paper and sell treasuries, making a 1.50% spread on the transaction.  Treasury Secretary Paulson, the great arbitrageur is showing his Goldman Sachs roots in this trade.   Everyone should be doing this trade, but doing so requires room on a corporate or bank balance sheet.  The Fed has virtually unlimited room to do this trade.  The result is that the Treasury - Mortgage spread will narrow.

The key point of this is that the rate the GSEs pay for new mortgages is determined by the price its debt trades at in the open market.  I would expect that by this time next week, 30-year mortgage rates will fall at least 25 basis point to around 5.75%.  What will that mean to housing prices.  Lower monthly payments will equate to an immediate increase in value of existing homes of 3%.  As mortgage rates continue to fall, housing values will be bolstered.  You should download my mortgage calculator and check the numbers yourself.