Feds Explains Plan To Wind Down Support Of Mortgage Backed Securities

While the fallout from the mortgage crisis is far from over, the immediate threat has passed, and the Federal Reserve is trying to figure out the best way …

While the fallout from the mortgage crisis is far from over, the immediate threat has passed, and the Federal Reserve is trying to figure out the best way to exit the mortgage backed securities business, without endangering US economic recovery. Extending and expanding the asset purchase programs, reverse repurchase agreements and government sale of mortgage securities are among the options the Fed is currently considering. See the following article from HousingWire for more on this.

Federal Reserve Bank of New York president and CEO William Dudley said on Monday the Fed’s work is far from complete “although the raging crisis appears to be over.”

And according to Federal Reserve chairman Ben Bernanke, a series of policy wind-down methods are being tested. The Fed may first drain excess reserves built up over many months through extraordinary asset-purchase programs, and then begin to raise interest rates. Or the Fed could pursue both options simultaneous to facilitate a quicker exit. Ultimately, economic developments will determine the exit process.

Several key Fed programs aimed at the mortgage industry – the $1.25trn agency mortgage-backed securities (MBS) purchase program and Term Asset-Backed Securities Loan Facility (TALF) to complement private-capital purchases of both legacy and newly-issued commercial MBS – are weeks and months from termination. Until then, the Fed is still engaged in a transition period designed to encourage the private market return to securitization – in both demand and supply roles.

For months, the Fed has played a significant demand role, buying up billions of MBS from Freddie Mac (FRE: 1.24 +3.33%), Fannie Mae (FNM: 1.04 +6.12%) and Ginnie Mae on a weekly basis.

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“These asset purchases, which had the additional effect of substantially increasing the reserves that depository institutions hold with the Federal Reserve Banks, have helped lower interest rates and spreads in the mortgage market and other key credit markets, thereby promoting economic growth,” Bernanke said in prepared comments to a House panel.

The MBS purchases are winding down and set to complete by the end of March, along with TALF for legacy CMBS. The Fed is also on schedule to buy about $175bn of agency debt securities by the end of March. The TALF program for newly issued CMBS is scheduled to complete by the end of June.

The Fed has considered extending and expanding asset-purchase programs, including the agency MBS program, if its exit this quarter is not replaced with private investor demand, causing MBS spreads to treasuries to blow out again.

Meanwhile, Bernanke said, the Fed is developing a toolbelt of methods to reduce the large volume of reserves and MBS held by the federal banking system. One such tool is reverse repurchase agreements (reverse repos), a way for the Fed to drain reserves by selling a security to a counterparty with an agreement to repurchase it at a later date. The counterparty’s payment to the Fed has the effect of draining an equal amount of reserves from the banking system. According to Bernanke, the Fed is in the process of setting up a reverse repo system for MBS holdings.

He said the Fed can also redeem or sell securities as a way to apply monetary restraint. A reduction in securities holdings would have the effect of reducing the quantity of reserves in the banking system as well as the size of the Fed’s balance sheet.

The Fed could continue to test methods for draining reserves, eventually scaling up these processes over time as market participants grow more prepared for the removal of policy accommodation. Bernanke said this method would give the Fed tighter control over short-term interest rates. Any actual firming of policy would be phased-in through an increase in the interest rate paid on reserves.

However, if economic and financial developments require a more rapid exit, Bernanke indicated these processes – significant reserve draining operations and higher interest paid on reserves – could be implemented at the same time.

“I currently do not anticipate that the Federal Reserve will sell any of its security holdings in the near term, at least until after policy tightening has gotten under way and the economy is clearly in a sustainable recovery,” he said. “However, to help reduce the size of our balance sheet and the quantity of reserves, we are allowing agency debt and MBS to run off as they mature or are prepaid.”

Bernanke added: “Although passively redeeming agency debt and MBS as they mature or are prepaid will move us in that direction, the Federal Reserve may also choose to sell securities in the future when the economic recovery is sufficiently advanced and the [Federal Open Market Committee] has determined that the associated financial tightening is warranted. Any such sales would be at a gradual pace, would be clearly communicated to market participants, and would entail appropriate consideration of economic conditions.”

This article has been republished from HousingWire. You can also view this article at
HousingWire, a mortgage and real estate news site.

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