Feb232013

The Federal Reserve owns 10% of all residental mortgage debt, increasing 5% per year

The Federal Reserve (US central bank) influences interest rates and by extension mortgages rates.  One of their key tools is the buy or selling of bonds, it adds or subtracts money from the money supply .  Since 2008 and the Federal Reserve has purchased over $1 trillion dollars worth of US residential mortgages in the form of bonds.  The effect of this unprecedented mortgage bond purchasing  pushed mortgage rates down to the lowest levels since the 1940’s.  This $1 trillion dollar figure represents 10% of the of the outstanding residential mortgages in the US.federal_reserve_printing_money

 To explain it in another way, if you have a residential mortgage there is a 10% chance that it’s owned by the Federal Reserve.  This is an incredible infusion of cash into the mortgage system.  If fact, its one of the reason why banks don’t pay interest on cash deposits.  Banks can get cash through the Federal Reserve with overnight loans and mortgage purchases.

What is even more incredible is that through the Quantitative Easing Program (money creation) the Federal Reserve is purchasing $45 billion of mortgage bonds each month.  This is about $540 billion of mortgage per year or of 5% of the existing resident mortgage debt.  Since this program is expected to last several years (to suppress the mortgage rates) by the end of 2015 the Federal Reserve will 25% of the existing residential mortgages.

Normally, mortgage bonds were purchased by banks, insurance companies, hedge funds, pensions and mutual funds.  Now the total mortgage pool/debt is slowly and incrementally purchased by the federal reserve. There is one question I ask myself:

What will be the end game and what will the affect the on the mortgage market?

The problem is how do you sell the assets without greatly increasing the mortgages rates?  Sooner or later the Fed will have to sell these assets and when they do it will create a problem they originally wanted to avoid.  When all these mortgage bonds hit the market it will drive down prices and increase mortgage rates to the consumer.  Even a slow sell off will create higher mortgage rates.

The Federal Reserve is looking for a slow increase in mortgage rates over many years, but probably not starting until late to mid decade. The sell off will probably trigger steeper increase in mortgage rates.  This will not only slow down buying, but push home values down lower. For Example, if mortgage rates increase from 4% to 6% that’s about a 25% decrease of purchasing power for the buyer.

I think this trap is starting to be realized by several major players.

Fed minutes send warning on durability of bond buying

By Alister Bull and Pedro da Costa

The Fed has more than tripled the size of its balance sheet since 2008 to around $3 trillion through purchases of bonds designed to hold down the cost of long-term borrowing and spur a stronger recovery.

The Fed has said it will reduce the size of its balance sheet when the time comes to tighten monetary policy. The central bank will use its March meeting to review the language it has used in its post-meeting statements pertaining to the possible costs of unconventional policy, the minutes said.

In an interview with Reuters on Tuesday, Atlanta Federal Reserve Bank President Dennis Lockhart said the Fed’s ultra-loose policy stance is still justified.

“I would not say at this point that, in any respect, the costs, which are largely longer-term and speculative, outweigh the benefits of maintaining a highly accommodative climate,” he said.

And some other articles.

The other side of QE

The Fed’s D-Rate: 4.5% At Dec 31, 2013… And Dropping Fast

Nouriel Roubini Is Bullish…For Now: “The Mother of All Bubbles” Has Begun

In English, the dangers of a long term assets bubbles and purchasing 10% of the mortgage bonds to lower mortgage rates to increase home values is an asset bubble.   It’s impossible to turn to history and see what are the possible comes of all this bond purchasing, because the US never been down this road before.  Now, the exit from this policy very problematic.  Finally, Congress is getting worried too.

Congress Asks Bernanke For Full Risk Analysis On Fed’s Soaring Balance Sheet

Submitted by Tyler Durden on 02/21/2013

The Committee has previously written to you with concerns about monetary policy in the United States. In July 2011, after a meeting between Committee staff and Federal Reserve staff, the Committee requested that you provide all Federal Reserve studies used to determine the value of Federal Reserve assets and “what the potential losses would be based on different unwind scenarios regarding the Federal Reserve’s portfolio…” The Committee also requested that you provide “all estimates and analysis of the potential costs of payment of interest on reserves” that would incentivize banks to maintain excess reserves. In response, you provided only publicly released studies, and you did not provide any precise estimates of the future cost of reserve interest rate payments

Good, I’m glad there is finally more people taking notice.  This is a start but we need to do more the can-kicking is not working out.

The Federal Reserve’s QE purchases of the 10% mortgage debt market has created ultra low mortgage rates.  However, it looks like it will do the opposite once these security must be sold.  This creating a boom and bust cycle.  The whole point and design of the Federal Reserve was to prevent large swings in the economy, fight inflation, and promote stability.  This this QE program providing stability?

Or you can listen to this guy?

Bernanke: “There Is No Bubble”