Here’s a lil’ history lesson for y’all on how this Fed mortgage-backed securities program came to be. As we all know, the start of the global recession essentially began with the collapse of the US housing market. So what did the Fed do?
With the possibility of the housing market hitting rock bottom, the Fed stepped in to try to save the day. The Fed started buying up $1.25 trillion dollars worth of mortgage-backed securities (MBS) from loan titans Freddie Mac and Fannie Mae. The Fed’s aim was to keep mortgage rates low in order to entice consumers to take out loans for their homes. By having unlimited buying power in the secondary bond mortgage market, the Fed would help stabilize the housing market.
How does this work?
Remember, at the time, the recession was in full swing and many investors were risk averse. If the Federal Reserve didn’t offer to buy up MBS bonds, it would force lenders like commercial banks to raise yields in order to compensate other investors for taking up the bonds. In turn, lenders would have to charge higher mortgage rates to potential homeowners, which would lead to a deeper hole in the housing market.
During the length of the MBS program, mortgage rates went to its lowest levels in more than five decades. The record low rates, along with other government stimulus programs, like the $8,000 tax credit for new home buyers, helped prop up demand for real-estate by keeping mortgage rates affordable for potential homeowners.
Although home demand for houses isn’t as “healthy” as it was two years ago, you could probably say that the housing market isn’t bad as it could have been. In fact, the most recent Standard & Poor / Case-Shiller HPI showed that the selling price of single-family homes only declined 0.7% in February, which was a significant improvement from the 19% fall a year before.
Now that the program is coming to an end, the big question is that begs to be asked is, “What now?”
Firstly, interest rates on mortgage loans could rise once the Fed ends its purchase of mortgage-backed securities. When the Fed removes its hold on MBS assets, private investors could start demanding for higher rates for the risks that they are taking, shaking up the already shaky ground the US housing market is standing on.
Furthermore, new home buyers would have a tougher time affording a house, probably causing another dent in the housing market. Also, those who have availed of those mortgages with adjustable rates would likewise get affected. Let’s say you bought a home with a 30-year, 3% adjustable rate mortgage. Now, if mortgage rates were to jump to 5%, you might find yourself scrambling to find ways to pay off your monthly interest payments.
If the end of the Fed’s bond mortgage program pulls the rug from under the housing market’s fragile legs, the markets could get hit by a huge wave of risk aversion similar to the ones seen during the last recession. If the troubles in the housing market come back to haunt the US, investors might start buying up the safe-haven US dollar, fearing that a temporary dip could lead to a full-blown crisis.
However, a possible deterioration of the housing industry could give rise to speculations that the entire US economy won’t be able to survive without the help of the Fed’s programs. This could force investors to park their money elsewhere, thinking that it would take the Fed much longer to pull out their easing programs. Given this, extending the “extended period of low interest rates” won’t be such a remote possibility…