Fed Closes Its Wallet on MBS...Private Investors to Fill the Void?
After 15 months of unprecedented intervention in the secondary mortgage market, the Federal Reserve—currently the proud owner of nearly 25 percent of mortgage debts—is calling it quits. The Fed's $1.25 trillion emergency program to stabilize the U.S. housing market through the purchase of mortgage-backed securities (MBS) officially expires today.
First announced in November 2008, the Fed initiative to purchase MBS issued by government sponsored enterprises (GSEs )—including Fannie Mae, Freddie Mac, and Ginnie Mae—has largely been viewed as a catalyst in spurring the nascent recoveries in both the housing and stock markets, helping to lower home mortgage rates and free up capital for private investors. In particular, market analysts credit the Fed purchasing program with paving the way for a record $375.4 billion of investments into bond mutual funds in 2009, as lower returns on mortgage securities led investors to corporate bonds, equities, and other riskier assets.
At a time when the U.S. economy remains fragile, the Fed’s departure from the housing sector may help determine just how fragile economic conditions really are. For months, market observers have raised concerns that a Fed exit could cause significant spikes in mortgage rates, leading to higher foreclosures and a slump in investor confidence. In fact, Fannie Mae's and Freddie Mac’s February announcement that they will repurchase $200 billion in delinquent mortgage loans, was a tacit acknowledgement that government backstops cannot be removed swiftly.
However, a number of analysts are also predicting that the effects of the Fed pullout will be rather minimal, as the current shortage of AAA-rated debt has made private fund managers increasingly eager to begin reinvesting in MBS, especially when such securities are backed by propped-up GSEs like Fannie Mae and Freddie Mac. In addition, these analysts also project that U.S. banks—which have steadily increased capital levels and are now flush with extra cash—will step up to fill the void left by the Fed.
The role of both Fannie and Freddie in ensuring a smooth transition for the housing finance system will be something to watch closely over the next few months. The GSEs are under intensified scrutiny on Capitol Hill, as the Obama administration prepares a sweeping proposal for a GSE overhaul. Treasury Secretary Tim Geithner told Congress last week that the administration will initiate a public comment period on April 15 in order to solicit ideas for Fannie and Freddie’s restructuring.
