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Mortgage Securities It Holds Pose Sticky Problem For Fed

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http://www.nytimes.com/2010/07/23/business/23banks.html?_r=1&ref=business

The Federal Reserve provided most of the money for new mortgages in the United States last year, effectively lending more than $1 trillion to American homeowners.

Now the legacy of that extraordinary intervention is hanging over the central bank as it faces growing demands for an encore to help revive the flagging economy.

While officials and economists generally regard the program as successful in supporting the housing market, it has left the Fed holding a vast pile of mortgage securities — basically i.o.u.’s from homeowners — that it does not want and cannot sell.

Holding the securities could cost the Fed a lot of money and hamper its ability to fight inflation, while selling the securities could drain needed money from the still-weak economy.

Fed officials have expressed confidence that they can finesse the dilemma by gradually selling the securities as the economy starts to recover. But they are not eager to expand the challenge they face by beginning a new round of asset-buying, one tool the Fed could use to try to stimulate growth.

“In my view, any judgment to expand the balance sheet further should be subject to strict scrutiny,” Kevin M. Warsh, a Fed governor, said in a speech last month in Atlanta. He warned that new purchases could undermine the Fed’s “most valuable asset”: its credibility.

Some Democrats want the Fed to pump more money into the economy to help reduce unemployment, one of the central bank’s basic responsibilities. In testimony before Congress this week, Chairman Ben S. Bernanke said that the Fed retained that option, but did not now plan to expand on the steps it had already taken.

In part, Bernanke and other Fed officials say they believe that new asset purchases would be less effective now that private investors have returned to the market.

The Fed became one of the world’s largest mortgage investors because no one else was interested. During the fall 2008 financial crisis, investors stopped buying the mortgage securities issued by the housing finance companies Fannie Mae and Freddie Mac. The two companies buy mortgages made by banks and other lenders, providing money for new rounds of lending, then package those loans into securities for sale to investors, replenishing their own coffers.

Two days before Thanksgiving 2008, the Fed announced that it would buy $500 billion in securities issued by the two companies. By the time the program wound down in March 2010, it had spent more than twice that amount. The central bank now owns mortgage securities with a face value of $1.1 trillion.

A wide range of economists say the Fed’s program — so big that purchases outstripped the issuance of new securities in some months — helped to preserve the availability of mortgage loans and helped to hold interest rates near record lows. Rates that exceeded 6 percent in late 2008 remain below 5 percent today.

But the Fed now must deal with the cleanup.

The central bank could hold the securities until the borrowers repaid or refinanced their loans. Brian P. Sack, an executive at the Federal Reserve Bank of New York, estimated in March that borrowers would repay $200 billion by the end of 2011. And in the meantime, the Fed is collecting regular interest payments.

“We’ve been earning a fairly high income from our holdings and remitting that to the Treasury,” Mr. Bernanke told Congress on Wednesday.

But holding the securities could make it harder to control inflation as the economic recovery gains strength, said Vincent Reinhart, the former head of the Fed’s monetary policy division, now a resident scholar at the American Enterprise Institute.

The Fed bought the securities by pumping new money into the economy, stimulating growth. It could be difficult to reverse that effect without draining the money from the economy by selling the securities, Mr. Reinhart said.

“They created reserves, and those reserves ultimately can be inflationary,” Mr. Reinhart said. “The chief risk of keeping the balance sheet big and raising rates is that you might not be able to raise rates successfully” because the impact would be mitigated by the effect of the extra money still sloshing around the system.

Holding the securities also could cost the Fed a lot of money.

The Fed paid some of the highest prices on record for mortgage securities, basically accepting very low rates of interest on its investments. As the economy recovers and interest rates rise, the Fed will need to accept increasingly large discounts to make the securities attractive to other investors.

David Zervos, head of global fixed-income strategy at the investment bank Jefferies & Company, estimates that the value of the portfolio will drop almost $50 billion each time interest rates increase by one percentage point.

O dear, catch 22?

Sell them drain the economy of cash.

Hold them and lose money and be unable to fight inflation unless you are prepared to accept huge losses.

Excellent.

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http://www.nytimes.com/2010/07/23/business/23banks.html?_r=1&ref=business

O dear, catch 22?

Sell them drain the economy of cash.

Hold them and lose money and be unable to fight inflation unless you are prepared to accept huge losses.

Excellent.

The Fed can create money for free, just by printing it or running a computer program.

The real loss isnt felt by the Fed, but in the devaluation of all other dollar holders. I am sure that the Fed paid top dollar for these securities, knowing that they would make a paper loss on the transactions. But it helped keep banks solvent, and increased the total money in the US economy. Without this action, many US banks would now have gone under. Which is a pity, because many bad banks in the US should have gone down.

This is a really bad way to do QE. If you are going to do QE, best to use it to fund government back to work programs. Like building new railways, something I would advocate. Get people doing stuff, make the work manual, train people on the job to lay rails, be stone masons, learn about logistics and management. Overpaying for trash to keep bad banks looting the public, not a good way to do things.

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  • 261 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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