Fed Rate Cut Expected - Is that a good idea?

Implications: While many companies and investors are planning on what to do with cheaper money due to the rate cuts, one of the implications has been that a rate cut will help re-start the mortgage industry engine. Yes, originators will get some new refi's completed and earn some fee income, and there will be a few borrowers who were not in the market before that get in to it now. There will even be some purchases of some of the mortgage inventory. Due to tightening credit standards and qualification criteria, the number of new loans will be minimal and the refi's will be to the best credit worthy borrowers. Truthfully, the rate cuts of last week and this week will actually hurt the mortgage industry due to adverse selection in exisitng mortgage pools with subsequent accelerated write-downs.

Analysis: The exisitng mortgage pools are made up of performing and non-performing loans. The performing loans run the gamut of pristine borrowers (conforming loan pools) and paying as agreed borrowers (sub-prime) to defaulted and foreclosed borrowers who do not pay. The loans stay in the pools until they are liquidated and then the loss or gain is realized.
By taking the best credits out of both the conforming and non-conforming pools, the credit worthiness of the existing pools is comprimised. Also comprimised is the value of the Mortgage Servicing Rights (MSR's) which the servicer/lender must recognize. The MSR's have been one of the few bright spots with increased value as the pre-payment speeds have declined. Now pre-payments will increase with each refi and the exisitng pools will have fewer paying loans.
With fewer performing loans, the pools results will be lower causing an impact to the bond holder, the servicer and the insurer on the pools. Hardly a helping hand at this time.
Just imagine how Fannie and Freddie will feel having a loan currently at 7% that will refi to 5%. They get to watch their exisiting pool drop in value and get to give up 2% in the process of backing a new loan. Not what I would call winning math.