Many homeowners have seen their mortgage company change over the years. Right now, there is a 30% chance that the holder of your mortgage is the United States Government. In 2020, the Federal Reserve got special Congressional permission to buy Mortgage-Backed Securities (MBSs) when the Covid-19 pandemic hit and the economy came to a grinding halt. Now they are getting ready to sell them back into the market, beginning tomorrow, and experts are anticipating that mortgage rates will rise and become a bit harder to get for a while. This will cool the temperature of the housing market, and the Fed is hoping it will rein in housing inflation without wrecking the economy — but it won’t work.
Banks lend money to people to buy homes. But they only have so much to lend, and people want to borrow more. So, the financial industry created the Mortgage-Backed Security (MBS). Banks can take their mortgage loans, bundle them all together, and sell them to a larger institution for cash. This gives the banks back their cash to lend out, and they can repeat the bundling process for as long as there are MBS buyers.
Larger institutions buy the bundles from many banks and package them into even bigger bundles that eventually get big enough, and of high enough quality, to be sellable to the very largest institutions.
The first few times a bundle is sold, you receive a notice in the mail giving you a new name and address to which to send your mortgage payment. This usually happens soon after closing, and it can happen several times in the first year or two. Most homeowners just get used to it without knowing why: it doesn’t affect their mortgage schedule at all, so few people really care. Now you know.
Here’s where it gets dicey, where good intentions turn around and bite us on the a$$.
The Federal Reserve holds $2.7 trillion of MBSs on their balance sheet. The total MBS market is only around $9 trillion, so the Fed’s share makes up 30% of all MBSs in the wild. That’s why I say there’s a 30% chance that your mortgage is held by the US government. This doesn’t affect your mortgage at all, but it begs the question: What is our government doing getting into the business of buying and selling such volatile assets as mortgages?
The Fed had to get special approval from Treasury to buy the riskier MBSs. By enabling more mortgages to be written, a lot more money was pumped into the housing market right at the moment there was a rush of people who wanted to get out of cities (i.e., away from other people) and into their own home. A housing bubble formed, and home prices went way up. So did construction costs, which further accelerated the rise in home prices and drove the inventory of homes available for sale down to record lows of around one month. This pushed home prices up even further. Today we have the median price of a home in the US sitting at $440,300, an all-time high and up 36.5% in just two and a half years from $322,600. That is what we call housing inflation.
On September 1st, the Fed will kick off their plan to fight inflation by tightening the money supply. They will sell up to $30 billion MBSs each month. This will reduce the amount of cash floating around the economy, a process called “quantitative tightening” or just QT. The idea is that people and companies won’t be able to get their hands on as many dollars, so spending and prices will go down.
People pay off their mortgages slowly, on average taking around fifteen years. The Fed has only been buying MBSs for two and a half years and they don’t have enough time left to hold them to maturity. The timing is especially poor because they will be selling into a market where the interest rates earned by holders of newer MBSs are higher than those the Fed holds, so the Fed must sell theirs for less than they paid and take a loss. This will reduce the amount of money the Fed gives back to the Treasury each year, further increasing the already sky-high budget deficit.
How did the Fed get into this mess? It was to keep the housing market afloat when Covid-19 hit. Last Thursday, the 30-year fixed mortgage rate was at 5.55% and the 10-year Treasury Note was yielding 3.10%. This implies that the premium consumers pay for their higher-risk mortgages is 2.45%. The Fed estimates the premium would have been higher by 0.50%, at 2.95%, if they had not stepped into the market buying MBSs to back up the banks. Mortgage rates would be over 6% if it wasn’t for the Fed’s action.
While 6% is far less than the 1981 peak of 18.63%, it is still the highest since the Great Financial Crisis of 2008. The generation growing up and buying homes have not seen conditions like these in their adult lifetimes, and it is kind of scary.
As MBS selling continues, no one is really certain what will happen. Theory says the larger supply will bring MBS prices down and decrease demand, which will cause mortgage rates to rise and make it harder for banks to issue more of them. This is going to cause pressures to build up throughout the economy.
The road ahead is very uncertain and definitely rocky. I may take this thinking further in a future Musing, but it gets kind of complicated and depressing. Let me know through the “Comments” section if you want a deeper explanation of how mortgage effects tie into the economy and lead toward both recession and higher inflation, a phenomenon known as “stagflation”. I can also discuss what we can do to somewhat protect ourselves.
For now, I hope you are happy to know why your mortgage holder changes and that the Fed is trying to cover your back. Just be aware that we are entering a new period of change on Thursday and that the way the future will unfold is far from certain.
Thanks for reading,
Ed