There’s no doubt we were lucky to have the Treasury Department under Steven Mnuchin take quick action once the Coronavirus hit the U.S. The stimulus packages passed by Congress and the Federal Reserve Bank’s interest rate cut to zero were a lesson on how government intervention can and should support the economy and stabilize markets in a crisis.
But that doesn’t mean there weren’t some disastrous consequences. Since March the Fed has purchased a record $1 trillion of mortgage bonds and now owns a third of all bonds backed by U.S. home loans. The bulk of the buying came in March and April, when the Fed bought $600 billion worth of mortgage bonds.
Since then that pace has slowed to about $100 billion a month. If that continues, The Fed is on track to own 34% of all mortgage bonds, the same amount it owned in the period from Sept. 2012 to Oct. 2014 during the QE3 quantitative easing, by the end of the year.
The idea behind gobbling up mortgage securities was to blunt the impact of the pandemic on American homeowners. And indeed, the move pushed mortgage rates lower — the average 30 year rate was 2.91% in September, down from 3.3% in early February — allowing strapped Americans to refinance for some much needed savings and homebuyers to continue their record pace of purchasing once markets reopened.
But the truth is, consumers, particularly high net worth and mass affluent individuals, might have been better off if the Fed had not gone on its bond buying spree. Why? The Fed is essentially buying its own paper and in the process creating a big strain in the market. The gap between mortgage rates and benchmark 10-year Treasuries is the widest since the Great Recession — 2.9 percentage points compared to the 1.74 average of the last five years.
By owning so much of the mortgage-backed securities market, the Fed is essentially controlling rates and bloating its balance sheet, which is now $7 trillion compared to $4.7 trillion on March 18. In the end, consumers are not getting the lowest rates, especially in the Jumbo Mortgage market.
What’s more, the Fed almost single handedly blew up the entire mortgage lending system. Mortgage security shorts that lenders use to hedge lock-in rates before loans are finalized suddenly turned to margin calls in the wake of the Feds buying spree. Margin calls may have drained as much as $5 billion form lenders and some of the biggest names were suddenly in deep trouble. In fact, every lender on planet earth was wobbling until the Fed eased up on its buying.
By lessening our dependence on leverage and establishing new partnerships, PCMA weathered the consequences of the FED’s actions and has come back strong. But I have an important question to ask going forward.
The Fed controls the primary liquidity of housing but only for safe harbor and QM loans. As much as 30% of U.S. households do not meet safe harbor standards, including creditworthy high net worth and mass affluent individuals who turn to private lending. If the Fed is backstopping the agency markets, would they consider backstopping private capital markets to make a truly equitable situation?
You know the answer — not likely. In the meantime we will continue to safeguard our non-bank lending practices to continue to offer outstanding service to our private lending clients.