By Joseph Trevisani, Published: 03/15/2010
The Federal Reserve has paid a yearlong bribe to the housing market to keep mortgage rates almost a full point below average. The $1.25 trillion payoff also known as the Mortgage Backed Security purchase program is about to end. Will the mortgage market stay bought?
Honest corruption is when a bribed official performs as promised without asking for more money or welshing on the deal entirely. It is a variant on Senator George Washington Plunkitt's famous term 'honest graft'. Senator Plunkitt, a 19th century New York Tammany leader said it best, Yes, many of our men have grown rich in politics. I have myself. I've made a big fortune out of the game, and I'm gettin' richer every day, but I've not gone in for dishonest graft - blackmailin' gamblers, saloonkeepers, disorderly people, etc. - and neither has any of the men who have made big fortunes in politics. There's an honest graft, and I'm an example of how it works. I might sum up the whole thing by sayin': I seen my opportunities and I took 'em.
The Fed first announced the Mortgage Backed Security (MBS) program in late November 2008 and expanded it to $1.25 trillion on March 18th last year. Purchases of fixed rate agency MBS paper--Fannie Mae, Freddie Mac and Ginnie Mae only--began in January 2009 and will end at the end of this month. In the Fed's description, The goal of the program is to provide support to the mortgage and housing markets and to foster improved conditions in financial markets more generally. In practical terms, the program has two intentions, keep mortgage rates from rising and keep the funds flowing to the housing market.
Since the larger Federal Reserve MBS purchase began last March, the monthly national average for 30 year fixed rate mortgages has been 5.15%. The low was 4.89% in that month and the high was 5.39% the following June. In 2008 the average for a 30-year mortgage was 5.90%, in 2007 5.93%; in 2006 it was 5.95%. For the first eight years of the decade, 30-year mortgages averaged 6.08%. In effect the Fed MBS program provided about a 75 basis point easing for potential homebuyers.
However, low mortgage rates were not the only goal of the Federal Reserve Governors; the central bankers also desperately wanted to keep the supply of lending dollars open.
The majority of home mortgages in this country are packaged and sold as securities by the three Federal Government Sponsored Entities (GSE) mentioned above. The original implicit Federal guarantee of this GSE paper became explicit when the government took over Fannie Mae and Freddie Mac during the financial crisis.
Fannie and Freddie buy mortgages issued by private lenders, package them into securities and sell the created MBS paper to the market. In the process, the private mortgage lenders sell their existing loans to the government and use the proceeds to fund new mortgages. Last spring the MBS market disappeared. Investors did not want securitized paper in any form, backed by GSEs and the US Treasury or not.
If the government mortgage twins could not sell their paper then the private lenders whose loans they repackaged could not recycle their existing loans into new cash for the mortgage market. The funds for new mortgages would dry up. In the panicked cash hoarding mindset of the credit markets at the time, the complete failure of the mortgage securitization market would have been another blow to market confidence. The Fed could not take that risk.
The Fed became the buyer of last resort and in effect, the holder of almost all the new MBS paper issued. As the economy slowly recovered from the financial crisis this support for mortgages along with the tax credit helped to rebuild the market for existing homes.
In January existing homes sold at an annual rate of 5.05 million homes. Though this was less than the 5.50 rate predicted by economists it is not much lower than historical rates over the past decade. In 2000 existing homes sold at average of 5.19 million annually per month, in 2001 5.33 million, in 2002 5.67 million. Only in 2003 did sales break above 6 million at 6.18. Sales peaked at 7.25 million in September 2005 and reached bottom in January 2009 at 4.53 million. The current four month moving average of 5.74 million per year is very much in the range of average sales of homes prior to the boom years of 2003, 2004, 2005 and 2006.
Pending homes sales are now predicting a fall of existing home sales in the next few months. The rate at which people are pulling out of already contracted sales is rising. Most home are bought with mortgages and most contracts to purchase are contingent on the buyer obtaining a mortgage. The difficulty in finding a mortgage is the most likely cause for the rising number of broken contracts.
The ending of the MBS purchase program is not a cause for alarm. Mortgage rates will rise. The Fed cannot permanently support the housing market. Sales have returned to low historical levels. Even if sales fall again in the coming months as the oversupply of new homes is worked off, the yearlong recovery is proof that despite the high unemployment there are a ready supply of buyers if the price is competitive.
The Fed's MBS program was an emergency measure designed to keep the housing sector from completely collapsing last spring. The bribe worked; the housing market will stay bought.