On MBS, Fed needs to point to the exit

September 21, 2009

When the medication is flowing, it’s hard to see straight.

Amid the giddiness in the markets and the cheers for the end of the recession, what often gets ignored is the fact that government stimulus is still fueling the reflation of financial markets.

Yes, the U.S. government has started to retire some programs — its backing of money market funds being the most recent. But there’s still a question mark about how it plans to wind down one of its largest supports — its $1.25 trillion mortgage-backed securities purchase plan — that is due to expire at the end of the year.

That’s dangerous, since a bungled hand-over of the market back to the private sector could derail a still fragile housing market.

This week, Ben Bernanke and his colleagues on the policy-making Federal Open Market Committee are sure to discuss how best to wind down its purchases of mortgage bonds guaranteed by state-run Fannie Mae and Freddie Mac. Some officials have already started to debate publicly whether they should pull the plug on the program before it reaches its $1.25 trillion limit.

But they shouldn’t wait to decide until November, as some now expect. They need to prepare investors elbowed aside by the government intervention. They should do this by laying the groundwork for an eventual departure, to avoid sudden spikes in mortgage rates that have been kept artificially low this year.

Unlike other initiatives, such as the Federal Deposit Insurance Corp’s insurance of bank debt, and the various lending facilities to nudge investors back into areas that had gone haywire during the financial crisis, the Fed’s direct purchases of MBS has done the opposite — it has squeezed investors out of the market.

“There’s a crowding out effect,” notes Walt Schmidt, a mortgage strategist at FTN Financial.

Foreign central banks, which had been big buyers, have cut their holdings of MBS and agency debt by roughly $200 billion over the last year, preferring instead to put their money in Treasuries.

Outflows have been even more impressive among households, according to Fed data that lumps domestic hedge funds and other groups that are difficult to track into this category. Their holdings have plummeted from $820.1 billion to $129.5 billion at the end of June.

The Fed has been there to soak up that selling, buying more than $860 billion through September 16. This has helped push risk premiums to around 1.42 percentage point over Treasuries — well below the nearly 3.0 percentage points peak seen in 2008. These risk premiums influence mortgage rates.

The Fed, therefore, needs to be precise about how it plans to end the program, since it could take some time — and much higher risk premiums — to fill the void.

Surely, a gradual approach is best to avoid abrupt disruptions, but it needs to get started, given its outsized influence on the market.

This week’s FOMC statement is as good a place as any to start. It will give policy makers ample room to fine-tune purchases to smooth the transition to what will surely be higher mortgage rates.

It will also act as a much needed reality check in broader financial markets that are confusing the medicine with the cure.


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Interests rates should probabley been twenty % last yr , considering the risk , You seem to think private financing will bail the government out of there predicument . The only way to sell those loans is with about a 50% reduction in value , And in many cities and properties that is not enough . United States is just starting to be pulling into a more reasonable finacial position . Spending has finally been brought down to a 100 % of income . Still to much spending , If interest should go up prematurely ,we would be back to losing headway evrey month . This yr we have had zero intrest and it took this to balance spending and income.
In order to susbtain ourselve we really should have a higher income than what we spend . The government seems to be able to say anything they want to and sure enough we seem to still believe them . Yrs ago interest rates were held high and the excuse was the government borrows to much money and pushes interest rates up for all of us . Now the government wants evreyone to buy a new car and help the economy . When evreyone bought a house like the government wanted them too that was bad and ruined the economy . If the government needs more money they sometimes recomend cut the taxes ,that helps the economy and brings lots more money into the government . Its nice a lot of people believe them and it has been proven true many times .

Posted by Eric Siverson | Report as abusive

agnes, mother’s little helper?

Posted by Matthew Goldstein | Report as abusive

I think the Fed and the other arms of the government are more worried about the sunami of mortgage foreclosures and arm adjustments than they are about the timing pulling the support out of the real estate market.
This isn’t a matter of ‘crowding out’ anyone, it’s a matter of healing market trust. When the financial wizards of wall street introduced adjustable mortgages they starved the tradional 30 year market of capital and overfed the short end…2,3 and 5 year arms creating an overvalued market. Foreign govt’s and US investors aren’t being crowded out, they have no faith in the value of the underlying assets and rightfully so.
If the Fed pulls the support of the mortgage market to early we risk the economy spiraling down again. This economy is standing on one leg…the government leg.

Posted by csodak | Report as abusive

Good one,

and a spoonful of sugar makes the medicine go down, hopefully nobody gets overdosed.

Very funny Matthew, Beatles lyric, maybe you could do with some of it to counter the effects of all the HFT going down.

Today I harbor the same thoughts, after opening up my preferred local web page that contained the following article:

http://www.businessday.co.za/articles/Co ntent.aspx?id=82250

Have a good one.

Posted by Casper Lab | Report as abusive

…sorry, must have had too much myself, make that the Rolling Stones.

Posted by Casper Lab | Report as abusive