March 11 (Bloomberg) -- Yields on agency mortgage securities relative to U.S. Treasuries traded near 22-year highs, as the Federal Reserve's plan to temporarily swap up to $200 billion of government debt for mortgage bonds failed to ease concern that a liquidity and capital crunch will continue to roil debt markets.

The difference in yields on the Bloomberg index for Fannie Mae's current-coupon, 30-year fixed-rate mortgage bonds and 10- year government notes narrowed about 5 basis points, to 223 basis points, paring a larger decline. The spread helps determine the interest rate on new prime home mortgages of $417,000 or less.

The drop still left the spread about 87 basis points wider than on Jan. 15, the recent low, and higher than last week. Banks and securities firms last month launched a new round of demands for more collateral on loans secured by debt to investment funds including Thornburg Mortgage Inc. and Carlyle Capital Corp., forcing sales and eroding potential returns, and few buyers have emerged. The spread reached the highest since 1986 on March 5.

The new Fed program announced today ``prevents things from getting considerably worse, and it helps the broker-dealer community a fair amount,'' said Ajay Rajadhyaksha, head of fixed- income strategy at Barclays Capital. ``But by the end of the day people will realize it's not a silver bullet.''

Shares of Fannie Mae and Freddie Mac, the government- chartered companies that guarantee most agency mortgage securities and represent two of the largest holders the bonds and other mortgage debt, rallied after plunging to the lowest since 1995 yesterday. Spreads on the companies' own debt narrowed. Markit ABX indexes, which are used to create derivatives tied to the performance of subprime-loan securities, climbed, suggesting a rise in prices for some home-loan bonds off record lows.

New Tool

The Fed set up a new tool, the Term Securities Lending Facility, to lend Treasuries to primary dealers, the 20 banks and securities firms that trade directly with the central bank, for 28-day periods, through weekly auctions. The Fed also said in a statement in Washington that it's increasing the amount of dollars available to European central banks through swap lines.

``Dealers now have more liquidity and financing ability than they had and they can pass that along to investors as they see fit,'' Kenneth Hackel, the managing director of fixed-income strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut, said in an interview today. ``The Fed's move doesn't completely resolve'' the effects of tighter bond-secured lending and trading difficulty, ``but it is a positive step.''

The move ``helps the liquidity situation: It doesn't necessarily change the supply-demand dynamics,'' Rajadhyaksha said in a telephone interview from New York today. ``One of the problems the mortgage market faces right now is that no one has capital to go out and buy more.''

Mortgage Debt

Outstanding agency mortgage securities, guaranteed by Fannie Mae and Freddie Mac or federal agency Ginnie Mae, total almost $4.5 trillion, about the same size as the U.S. Treasury market. Bloomberg current-coupon indexes represent the average of yields for the two groups of bonds with prices just above and below face value, the ones lenders typically package new loans into.

Shares of Washington-based Fannie Mae and Freddie Mac of Mclean, Virginia each jumped as much as more than 15 percent in New York Stock Exchange trading today, before pulling back. Fannie Mae rose 57 cents, or 3.3 percent, to $17.96, and Freddie Mac climbed 69 cents, or 3.5 percent, to $20.5 at 1:07 p.m.

Spreads tightened on the companies' direct obligations, which are also eligible to be swapped by dealers under the new Fed program. Spreads on Fannie Mae's five-year bonds over 5-year Treasuries dropped about 10 basis points from the highest in at least a decade to 103 basis points, according to Bloomberg data. That spread entered last month at about 64 basis points. A basis point is 0.01 percentage point.

ABX Index

An ABX index tied to 20 subprime-mortgage securities rated AAA when created in the second half of 2006 rose about 3 percent to a mid-price of 55 at 1:07 p.m., according to Deutsche Bank AG. That's still down from 74.19 on Feb. 1, according to London-based administrator Markit Group Ltd. The credit-default swaps cover losses if the securities aren't repaid as expected, in return for regular insurance-like premiums.

Prices for agency securities backed by adjustable-rate mortgages with at least three years of fixed rates fell 1.81 percent this month through yesterday, according to Lehman Brothers Holdings Inc. index data. Fixed-rated securities fell 1.39 percent, according to the New York-based company's indexes. The various classes of collateralized mortgage obligations used to repackage agency bonds collectively have fallen 1.08 percent, according to Merrill Lynch & Co. index data.

The Fed move should ease concern that brokers, such as New York-based Bear Stearns Cos., face a cash crunch, Rajadhyaksha said, especially because of the inclusion of AAA rated non-agency mortgage securities. Their quoted prices have tumbled this year by about four times the amount as they did last year, he said.

Spread Surge

Spreads have surged as investors assume that banks have little room to make new investments or maintain credit to funds at previous terms amid rising losses and a flood of unwanted assets, according to bond buyers such as Scott Simon, head of mortgage-backed bonds at Pacific Investment Management Co.

The Fed announcement today stops short of the direct U.S. purchases of agency mortgage securities called for yesterday by Simon, whose Newport Beach, California-based unit of Allianz SE runs the world's largest bond fund.

RBS's Hackel earlier today recommended for the first time in two months that investors add more agency mortgage securities to their holdings than are found in benchmark bond indexes because the yields offered over benchmarks had become ``very difficult to ignore.'' The Fed announcement makes the suggestion well-timed, he said in the telephone interview.

Barclays' Rajadhyaksha published a report before the announcement in which he moved to a ``neutral'' outlook for spreads, partly citing possible government intervention.

``It would have been better if this announcement had been extended to non-banks and non-broker dealers also'' because previous Fed actions through those firms meant to stabilize bond markets usually haven't been fully passed on through their lending to other investors, Rajadhyaksha said in the interview.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

Last Updated: March 11, 2008 13:31 EDT