The Federal Reserve (the Fed) is drawing on its full toolset to keep the economy from failing in the wake of 2020’s financial crash, pandemic and looming recession. A big part of that effort is keeping the real estate market afloat. Enter mortgage-backed securities (MBS’s).
Since the end of February 2020, the Fed’s balance sheet has increased over 60%, equal to an additional $2.6 trillion. The Fed’s total balance crested $6.7 trillion in the first week of May.
Looking back, prior to the 2008 Great Recession, the Fed carried just $870 billion assets. This changed quickly when the Fed instituted the first of three rounds of quantitative easing (QE) and began purchasing securities, including MBS’s, to prop up the economy during the elongated recovery from the 2008 recession. Their total balance increased to roughly $4.5 trillion by 2015 and remained flat until 2018, when the Fed’s balance sheet finally began to — gradually — decrease. This all changed at the start of 2020 when what was shaping up to be a moderate recession was disrupted by a pandemic and financial crash.
Federal Reserve Balance Sheet
Total assets (in millions of dollars)
Source: Federal Reserve
Why does the Fed purchase MBS’s and other securities during a financial crisis?
The Fed is sometimes referred to as the lender of last resort. What this means is, rather than letting the free market determine prices, the Fed can step in to force lenders’ hands.
The Fed claims its goal in purchasing Treasury securities and MBS’s is to: “support the flow of credit to households and businesses [and] to support smooth market functioning.”
This type of QE flushes the market with cash, decreases interest rates and generally makes it easier for businesses and individuals to borrow. At the end of March 2020, the Fed announced it would be calling on its powers to purchase an unlimited amount of securities to support the economy.
The big downside to today’s MBS purchases
QE is a relatively new economic practice. In fact, the first time it was used in the U.S. was in response to the 2008 recession. So, it won’t surprise you to learn there are still some bugs to work out.
This time around, the Fed’s outsized purchase of MBS’s has led to a jump in margin calls, which has been especially hard on independent mortgage loan brokers (MLBs). When an account falls below a certain value — as has been occurring more and more with the Fed’s significant MBS purchases — a margin call is triggered for the investor to pay more money to bring their equity back above the required maintenance margin.
The Mortgage Bankers Association (MBA) recently implored the Securities and Exchange Commission (SEC) to take these margin calls seriously. They point out that with the volatility in interest rates, the Fed’s MBS purchases are throwing off the hedge that lenders build into the rates they offer borrowers. This has resulted in huge losses to lenders, which are, in the words of the MBA, “staggering and unprecedented.”
Too much medicine can kill you.
Unless the government is planning on a bailout for MLBs, they need to work together with lenders to find a solution. This might look like:
- the Fed curbing their purchases and re-considering their QE strategy;
- MLBs re-thinking how they hedge; or
- the SEC stepping in to regulate hedging practices.
This spring’s high level of margin calls on top of rapidly rising forbearance rates have put the mortgage industry in a dangerous position. Today’s economic slump won’t end with a return to work or even a vaccine. The fact is, the 2020 recession has long been in the works, and the financial crash that hit earlier this year has only worsened the depth and extent of the coming recession. Our economy will be recovering from 2020 long after the pandemic is over.
Mortgage lenders know this and are quickly becoming more cautious, including tightening mortgage credit for borrowers. But more — and in the case of MBS purchases, perhaps less — needs to be done to ensure the mortgage industry survives 2020 and the years of recovery ahead.
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