Many of the government actions taken to minimize the effects of the real estate bubble and recession have been met with middling success at best. One program that has been a resounding success thus far is the purchase of $1.25 trillion worth of mortgage-backed securities in 2009.
The program was intended to keep mortgage rates low and promote lending. Mortgage rates were held at or below 5 percent for close to a year, hitting a historical low of 4.71 percent in December 2009. The problem is that the Federal Reserve will eventually need to reduce its balance sheet and sell some of its mortgage-backed securities, and there is no clear consensus amongst the board members as to how or when to sell the MBS, and what effect the sale will have.
If the sales of MBS are made too quickly, the market could be flooded and there would be downward pressure on these securities. In turn, borrowing costs could increase. This could lead to a spike in mortgage rates, which could damage the housing market and the economy as a whole, potentially slowing down the recovery or even halting it all together. While the latter possibility is improbable, it is possible, so the Fed is rightfully circumspect about these sales.
One of the fears the Fed has is that the market will misinterpret the sales. Everything the Federal Reserve says or does is subject to much scrutiny, and investors could take sales of MBS as a sign that the Fed is going to tighten its credit policy, while the Fed actually just wants to reduce its asset sheet. If the market misinterprets the sale of MBS, there could be wide-sweeping effects, including the general slow down of the economy.
The majority of Fed officials want to sell the MBS until after it begins the process of tightening credit, either by raising the federal funds overnight rate or prime rate. There are some Fed members who are in favor of selling off the MBS sooner because they are uneasy with the size of the Fed’s balance sheet, which has grown to historically high levels.
The takeaway for potential borrowers is the sale of MBS by the Fed could cause mortgage rates to increase. How do you think the Fed should handle the sale of mortgage backed securities? Let us know in the comments below.
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