The Real Deal New York

Fed could look to sell off MBS holdings

Central bank acquired $1.75T worth of mortgage-backed securities in wake of financial crisis
February 06, 2017 10:45AM

Janet Yellen (Credit: Getty Images)

Federal Reserve officials over the past few months have indicated they may be willing to reduce the $1.75 trillion worth of mortgage-backed securities it acquired as part of its experiment in quantitative easing amid the financial crisis.

The Fed is now the biggest buyer of U.S. government-backed mortgage debt, owning a third of the market, Bloomberg reported. But that’s long been a contentious issue, with some lawmakers arguing the investments go beyond what the central bank needs to achieve its mandate.

The Fed bought $387 billion worth of mortgage bonds last year alone in order to maintain its holdings.

Along with interest rates that have sat close to zero for years, the Fed’s demand for MBS has reduced the cost of mortgage debt relative to Treasuries, in turn encouraging banks to lend more to consumers. In a span of about two years that ended in 2014, the Fed increased its MBS holdings by roughly $1 trillion. Since then, 30-year bonds made up of Fannie Mae-backed mortgages have been about a percentage point higher than the average yield for five-and 10-year Treasuries, Bloomberg reported.

That’s a tighter spread than the market saw during the housing boom in 2005 and 2006.

The Fed last week kicked the can on raising interest rates again, but gave no indication when the next hike may come.

Unwinding quantitative easing could push the 30-year mortgage rate past 6 percent within three years, according to Moody’s Analytics. Rising mortgage rates are already putting a dent in demand in the housing market.

Dealers are anticipating that spreads will widen once the Fed starts to slow its MBS reinvestments. But putting MBS back into the hands of private investors could increase trading.

“Ending reinvestment will mean there are more bonds for the private sector to buy,” said Daniel Hyman, who is co-head of the agency-mortgage team at Pacific Investment Management Co. [Bloomberg]Rich Bockmann