04/03/2010 05:12 am ET | Updated May 25, 2011

Money Manager Says Interest Rate Worries Are Unfounded

As the Federal Reserve's trillion-dollar intervention to prop up the housing market comes to an end, the Obama administration and others have focused on whether the interest-rate hikes to ensue will wreck the nascent recovery.

Without the Fed single-handedly propping up the market with $1.25 trillion in purchases of mortgage-backed securities, interest rates will inevitably rise as reluctant private investors will need to be enticed with a higher rate of return to pick up the slack. Homeowners, the thinking goes, will suffer.

But those fears are misplaced, says Paul Colonna, who manages more than $58 billion as chief investment officer for fixed income at GE Asset Management in Stamford, Conn. Rather, borrowers need to repair their finances and banks need to get healthier.

Until that happens, a normalized housing market won't return, regardless of whether interest rates rise or stay steady, Colonna said Monday during a panel discussion at the American Securitization Forum's annual conference in Washington, D.C.

"We're going to see rates rise, but I'm not sure mortgage rates are really the problem," Colonna said. "It's much more of a credit story than an interest-rate story," meaning that today's high lending standards and the overall lack of credit for borrowers are the big impediments.

"That's the piece holding people back from getting mortgages," he said in an interview with the Huffington Post, dismissing the expected interest-rate hike.

While estimates place the expected rate increase somewhere between half to a full percentage point, Colonna said that won't be the factor that determines whether a prospective homeowner will ultimately buy.

"It's more that they can't qualify" for a loan, he said. The administration should stop focusing on interest rates, Colonna said. It should instead focus on allowing the market to normalize at its own pace, meaning it should essentially back off.

That'll be hard to do as foreclosures continue to increase and voters head to the polls in nine months. The administration is under pressure to keep families in their homes while fixing the housing market. Its response has been to keep interest rates artificially low and pressure banks to lend more -- something that needs to stop now, Colonna said.

Banks are under-capitalized, he said. They need to be allowed to get their finances in order before they start lending again. While the administration may have a different view, Colonna said, banks have to cut their lending and amass capital in order to get back into a natural lending cycle. Mortgages will then resume.

Banking "is a volatile business," he said. "The message should be: 'We want you to recapitalize, and be smart about extending credit and taking appropriate risks.'"

Higher interest rates, thus, aren't such a bad thing.