To Whom Does The Fed Intend To Sell Its MBS?

By the end of March, the Federal Reserve is set to end its mortgage-backed securities purchase program. This program was created to help alleviate the credit crunch for residential mortgages during the financial crisis. It has worked pretty well. Once the program ends next month the Fed will have approximately $1.25 trillion in MBS on its balance sheet. The Wall Street Journal's Real Time Economics blog reports that St. Louis Fed President James Bullard favors beginning to sell this MBS soon. My question for him would be: to whom?

From RTE:

"If the economy stays on track, I'd expect that at some point we'd entertain the possibility of asset sales," said Mr. Bullard, a 2010 voting member of the Fed's policy-making arm, adding it could happen later this year. The Fed official said the asset sales should be very slow at first to test markets.

He also believes asset sales should begin before rate increases, according to RTE. I have a few concerns.

I've already mentioned my fear that investors won't be willing or able to sustain the demand necessary to keep the MBS market moving once the Fed stops its purchases. If the program is ended too soon, that will lead to much higher mortgage rates and less mortgage availability. That's sure to drive the prices of homes even lower and make housing inventory even higher.

But not only is Bullard on board with ending the program, he's itching to start selling the MBS. Here's the problem: if there isn't enough investor demand to sustain a private new issue MBS market as it is, then to whom exactly would the Fed sell its MBS? The same problem would persist in the secondary market, unless the Fed is prepared to take deep discounts, which is unlikely, because if anyone can hold assets as long as they like, it's the Fed.

Why am I so convinced that the MBS market is still very unhealthy? Because it told me. Last week at the American Securitization Forum conference, the industry participants answered a poll about when they thought the RMBS market would begin to recover. Their answer:

mbs recovery.PNG

Only 8% say the market will get started again prior by mid-2010. A full 66% say it won't even happen this year. 39% think it won't happen until late 2011! So the Fed's influence will have to be significant over at least the next year, unless it wants to debilitate the housing recovery.

Let's think of a best-case scenario. The Fed ends its program in March, and that 8% is right: there are a handful of investors willing to play in the MBS market again. Those investors will have to soak up all of the new issue MBS. If the Fed is also trying to get rid of its MBS, then the market supply becomes greater, leading those investors to purchase less new issue MBS. That curtails origination and raises interest rates further. And again, this is the hopeful scenario.

As much as I hate to see the Fed's involvement in the mortgage market, I don't see how it can stop propping it up until we're sure house prices have hit bottom, inventory has declined to normal levels and the foreclosures are mostly finished. And that's just when it should stop its MBS purchases. It should finally sell its MBS even further down the road -- once there is ample demand again for MBS so that the market can absorb the supply shock of the release of all of those securities.

Presented by

Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.

Saving the Bees

Honeybees contribute more than $15 billion to the U.S. economy. A short documentary considers how desperate beekeepers are trying to keep their hives alive.

Join the Discussion

After you comment, click Post. If you’re not already logged in you will be asked to log in or register.

blog comments powered by Disqus

Video

How to Cook Spaghetti Squash (and Why)

Cooking for yourself is one of the surest ways to eat well.

Video

Before Tinder, a Tree

Looking for your soulmate? Write a letter to the "Bridegroom's Oak" in Germany.

Video

The Health Benefits of Going Outside

People spend too much time indoors. One solution: ecotherapy.

Video

Where High Tech Meets the 1950s

Why did Green Bank, West Virginia, ban wireless signals? For science.

Video

Yes, Quidditch Is Real

How J.K. Rowling's magical sport spread from Hogwarts to college campuses

Video

Would You Live in a Treehouse?

A treehouse can be an ideal office space, vacation rental, and way of reconnecting with your youth.

More in Business

Just In