The Fed's $2.7T mortgage problem
axios.com
axios.com
This isn't how it works.
No doubt, some will try to spin it that way. But the Fed balance sheet's gains and losses are an accounting artefact. (It will always make money when lowering rates. It will always lose money when raising them. This is close to mathematical fact.) The Fed can't go broke. Its operating metrics are inflation and unemployment.
> the selling would likely push mortgage rates up further, at a time the housing industry is already starting to groan under the pressure of rising rates
This is the real issue. But it's why we have an independent central bank. Nobody likes rate rises. It's why economies with weak institutions wind up hyper inflating. (No, we're not.)
For "homebuilders, real estate agents, and other influential industry groups," there is unlikely an upper bound to the support they feel they need.
I like rate rises. And I'd like a central bank run by people who didn't default to "nobody likes rate rises" thinking.
This article is literally about them printing money to buy private assets...
their job is to protect the big banks, the rest is window dressing for TV-americans
Open market operations are one among many of the Fed's policy tools [1].
[1] https://www.frbsf.org/education/teacher-resources/what-is-th...
The comment I responded to [1] posited the Fed needing to engage in extraordinary tightening. Waiting for the debt to be repaid would be insufficient in that case. (Also, defaults unbalance the equation.)
In that case, the Fed would need to sell assets to draw cash out of the economy. My point was that if the Fed ran its balance sheet to zero, it would still have unlimited firepower in the form of slashing interest on reserves through zero, borrowing through repos and potentially even raising the reserve requirement. These are powerful tools. Too powerful for regular use, which is why the more-precise open market operations are preferred.
TL; DR Running out of room to tighten is not a problem for a central bank.
I think this article is a bit of a nothingburger. Of course QT has the opposite effect of QE, that's the entire point. The 2020 housing boom will not blow up like in 2008 because today's mortgage backed securities are much more stable than the C-tier CDOs of yester-year, as long as the labor market is doing well (which it seems like it is[1]) and folks can afford their mortgages. Of course house prices may deflate (~20%?) purely out of demand for such high prices decreasing, but imo it's unlikely we will see mortgages go underwater, and therefore the Fed doesn't really have a problem on their hands.
[1] https://www.nytimes.com/2022/05/06/business/economy/jobs-rep...
Which is indeed the last shoe that has yet to drop in the current recession.
At 2.6%, 45% of your first payment goes toward the principal, and around 3.5 years into a 30 year mortgage you hit 50/50 split between the principal and interest.
At 5% interest, 22% of your first mortgage payment goes toward the principal and you only hit parity at around year 15-16.
At 10% interest rate, only 5% of your first mortgage payment goes toward the principal. You hit parity (50/50) around year 23.
CDOs did not blow up the housing market. The housing market blew up the CDO market.
In 2007, people said the exact same thing, and by every single metric the housing market is far more extended than it was then.
Both statements are correct because there was a feedback loop.
The consequences of the 2008 financial crisis reverberated for over a decade, and then COVID-19 pandemic arose and the government decided that it wasn't going to make the "same mistake" again and started bailing out everyone. However, they overshot, misallocated funds, caused runaway inflation, then failed to recognize the persistent inflation and acted too late to curb it. That brings us to today, where there is ongoing speculation about whether this will be a "soft landing" or a "hard landing." If history is any guide, then I think that this kind of market situation this means we can expect another spectacular crash in the near future. The consequences of the 2008 financial crisis and subsequent rescue operation were still unresolved when the pandemic began, because the Fed had not figured out how to unwind its bloated balance sheet from all those years of Quantitative Easing. Just when the Fed thought it would start unwinding, the pandemic hit, and the Fed balance sheet grew astronomically. Now, for the first time in decades, the Fed is facing the runaway inflation that "common sense" would have predicted, and they have no choice but to initiate a "rug pull" on the economy in order to bring inflation under control. This will only end when the US consumer is bruised badly enough to reduce consumption, which will put the economy into a tailspin which will cause massive wealth destruction for investors. It's hard to see how the Fed can keep kicking this can down the road. Somewhere along the way there will be a black swan event. Perhaps Russia will choose to escalate cyber, kinetic and/or economic warfare against NATO at the very moment that a US market crash is occurring.
I sincerely hope that I'm wrong, but my Spidey Sense is tingling like it's 2001 or 2008.
The two were indistinguishable (CDOs == buckets of over-leveraged mortgages), so I'm not sure what your point is here. No one really knew/cared what was in those CDOs, so people were trading them at face value. I don't think recent home owners are even remotely as leveraged as they were in 2008, so we're not risking a cascading blow-up effect.
House prices went up because of QE + high demand. QT will decrease demand at such high prices, and thus lower prices; we're already seeing this happen due to interest rate hikes. Undoubtedly we'll see some foreclosures, but I don't think it will be a bloodbath.
This is correct. The current boom will not blow up like in 2008, it will blow up in a new and unanticipated way. Likely due to complex and lightly regulated financial innovations that have grown in size since the last crash.
I don't think that the fed has wo worry about freeing up the capital to relocate because they printed it into existence in the first place. They also don't want to do more QE because the market is already overheated.
I certainly think the fed should stop to build the bubble, but it should also not go all in and crash everything.
Less housing demand presumably means less home construction and renovation, which eases the strain on supply-chain limited resources. Lower home prices also reduce the amount of equity sellers, or HELOC borrowers, can spend on NFTs or whatever [1].
Imagine an ad infinitum example. Let's say the price of gas goes to $1M a gallon. The fed then somehow removes every dollar from the economy. The price of gas is still going to be approaching zero when denominated in dollars after demand is forced to zero(in reality the price of gas would just change to be denominated in physical violence in this mad max scenario but that's an aside)
If someone want they can get a free lunch, no need to increase the rate but everyone else lowers inflation for them.
Which isn't really a problem... because it's impossible for the Fed to get called in the way a bank would if there's a housing crash.
But is probably less than ideal... as it's just weird to have the Fed holding that much mortgage debt directly.
There isn't one. The Fed wants to tighten financial conditions, and selling mortgages is a good way to do that for the same reason buying mortgages (or more precisely, mortgage-backed securities) is a good way to loosen them. Mortgages are simply more quotidien than e.g. Treasuries, and so could bring novel political risks.
They want to stifle the demand so as to match supply better, but when it's a supply shock and the United States is short something like 3 million houses, it seems a fairly punitive and misguided way to approach solving the problem.
Rates rising drives prices down. Of the mortgages on their books. And of the homes collateralizing them.
Add six people. There are now five chairs and ten people. How can you manipulate the prices of chairs such that all ten people can have their own chair?
Artificially lowering the prices of chairs does not solve the underlying issue: There are not enough chairs for everyone that needs one.
By treating housing price surges as excessive demand (raising mortgage rates), you lower demand not only for _existing_ homes, but also for creating new homes. If your goal is to ensure that housing prices always go up and affordability/homelessness go in wrong direction, the Federal Reserve's policy is very effective.
They're wrong to prematurely kill demand before it can cause new housing construction to increase, fixing the underlying issue of not enough supply.
Price always going up makes chairs attractive to hold, which results in misallocation of chairs - ideally you want them to go to whoever wants chairs the most, not whoever grabbed a chair first.
Yes, the best answer is to make more chairs, but that is not something that the FED has much control over (it's federal/state/local zoning policy and regulation which prevent more supply).
The question the FED can address is not "how can we make sure everyone has a chair", but rather "how do we make sure that the existing chairs go to the people that need chairs the most"
There's still a supply shortage in building homes to deal with, but that'd at least solve a problem for a good chunk of folks.
The solution is to remove tariffs on imported wood to make new housing cheaper and to punish municipalities with racial segregationist-era housing/zoning policies.
There are places like Mountain View that don't allow building above four stories, which is crap, but stuffing people into towering buildings where they're not allowed to own the thing they're living in or immediately priced out of it (which serves as an investment) doesn't solve the housing crisis.
Edit:
I had a bit of a snarky reply, and I apologize if you read that. I pay a little over $3.5k for a house (that allows a big dog); if I lose this place I'll pay over $4k in rent per month and that number goes up by the month. I'm being forced to come into an office, which requires me to live near by. If I can't live near by, then I have to accept a lower paying job. Do you see the complexity of this issue?
This is misguided politic theatrics, that causes even more panic and over consuming due to panic, which leads to further stress and supply issues.
Given that all treasury bonds that mature and most mortgage bonds paid off via home sales are refinanced, private investors -- that is, mutual funds, ETFs, pension plans, individuals, etc. -- will have to buy an additional ~$90B of bonds every month, give or take, going forward.
That's $1T/year that private investors must find to buy treasury and agency bonds newly issued to refinance old ones.
Without a doubt, this will have a large, persistent effect on treasury yields and credit spreads.
Yes.
> this will have a large, persistent effect on treasury yields and credit spreads
That's the point.
How is this bad news? Housing is incredibly expensive relative to the average American's salary. Yeah it sucks for people that bought a house recently, but in the long term, it is absolutely a good thing.
Why does this reduce the amount of funds to the treasury? The losses are on the Feds balance sheet. My understanding is that the Treasury is not involved here, but the article hints at them being affected. Is it implying that treasury yields will rocket higher???
> In that scenario, expect officials to face tough questions from Capitol Hill to explain why they've lost billions of dollars on behalf of the American people.
If the Fed takes a loss, doesn't this mean that base money supply increases? Sure it will be drawing liquidity out of the system, but in the long run, it will leave more money in the system compared to where they started with QE.
It's an accounting thing [1]. When the Fed makes a profit, it remits it to the Treasury [2]. (I believe this is an anachronism from the gold standard days, but not sure.)
[1] https://www.stlouisfed.org/on-the-economy/2018/september/fed...
[2] https://www.wsj.com/articles/fed-sent-88-5-billion-in-profit...
I think if the Fed announced they were selling agency MBS as part of their QT program we would see a paradigm shift in markets. Like limit down kind of days. I think that's what the punch bowl being taken away truly looks like.
And if the S&P down 35% doesn't get inflation down, then I think that's probably next on the list.
Selling these does not effect the housing market any differently from the Fed selling some other bond.
If the market will pay yield X for a long-term bond of a certain duration, banks can make money by offering mortgages for X plus some margin.
The Fed selling MBSs should just depress yields in general.
"Balance sheet that never rolls off" is very much in the same genre as "loan that is actually a grant" and "financing tax cuts with debt."
edit: /s
In reality, all of those steps were necessary to prevent economic disaster, but now that disaster has been averted, and wages started rising, everyone's clutching their pearls about inflation.
In any case, the team sports side of this is much less interesting than the part that transcends team sports: both sides devote more media attention to the smaller money printers. Not by a small margin, either. That's an interesting choice. Does submarine go blub? Or does making the big money printer boring and complicated completely cloak it from view? Either way, it's an impressive multi-trillion dollar sleight of hand.
The assertion is not so much that poor people cause inflation; rather, that inflationary fiscal and monetary policies are often only recognized as such when they happen to benefit middle-to-lower income people.
Example: PPP Covid programs which pay business owners billions is necessary and proper given the circumstances, but direct payments to taxpayers is not because it will cause inflation.
In truth, they both provide relief, and they both contribute to inflation.
Assets have been artificially inflated for a very long time due to QE and low interest rates and the Fed's balance sheet.
If that were single handedly the reason for corn and lumber to get more expensive (general inflation) - we should've seen that a long time ago.
There's a lot going on - and it's hard to blame everything on the Fed. Rising inequality? Sure. General inflation? Not convinced.
When wages go up, it can either go at the expense of profits, or at the expense of prices (Or, most usually, both). The labour shortage in the pandemic created upward wage pressure, which added to existing pressure[1] caused by rising housing/healthcare costs.
Notice how interest rates went up, as unemployment hit an all-time low? Capitalists hate low unemployment, as it causes wages to go up. Raising interest rates cools off the market, reduces the number of speculative investments, and increases unemployment.
There's a reason that the government always wants a few million people to always be jobless. It puts the brakes on wage growth.
[1] This is most notable in resort towns. As housing prices went up, nobody who works a service job can afford to live in them anymore - so all the workers pack up, and move to the city. As a result, businesses either have to raise wages, or shut down, or significantly reduce their hours. For some reason, tech folks vacationing in their lakeside dachas aren't keen on putting in a few hours at the local grocery.
If these were your only choices you were on the edge of profitability right before a global pandemic hit. Plenty of reasons for that. Commercial Rent Control is "progressive" and the people who own property like this can afford to let it sit vacant indefinitely and will literally abandon this amount of profit because they feel like it.
The problems with a debt crisis at the sovereign level is there is only one can left to kick and that's the inflation can. The government says they don't want inflation but if it comes down to real solvency issues, they are going to give in to inflation, if the choice is between that and defaulting.
We basically have been playing a liquidity shuffling game since the first tech bubble.
I think beyond that it's too many words to really get into?
from TFA: "The Fed's pandemic actions fueled a housing boom"
well thats part of the issue (pulling a mini tarp), but the other half of the story is the extraordinary steps taken way back in 2010 to keep people in their homes in the first place. The government wanted cake and they wanted to eat it too. Banks that over-leveraged and pandered predatory loans were never allowed to crash and burn; they were almost all bailed out through TARP. homeowners in turn who accepted these loans were also often gifted with TARP assistance that kept them in overvalued homes. auto-makers without customers were never made to reform, only a few token concessions and mergers here and there for companies with a track-record of dismal performance, and a well published cosmetic defect when executives from these conglomerates came with dog-eared pockets to congress on private jets.
Effectively, when the market ran out of gas, the federal government began expectorating ether into the air scoop of the economy like a wasteland war boy effectively trying to outrun any crash that didnt focus entirely on the poorest members of society.
That fix was just never paid for, in terms of shrinking Fed balance sheets and renormalizing rates.
Additionally, if you don't address the lack of regulation that allowed the collapses in 2008, which we absolutely did not, it will keep happening and those future occurrences will grow in severity. Since now, in order to 'make money', the frauds have to be bigger, faster, and more aggressive.
What does that even mean?
Do you mean it in a philosophical sense similar to the idea that every company will eventually go bankrupt given enough time? Any major crisis is capable of bringing down banks, its inherently a feature of fractional reserve banking but the benefits have so far outweighed the risks.