Major changes are coming to housing finance. The Federal Reserve is about to unwind a program that has held mortgage rates low for several years. How will this change impact housing? Lenders weighed-in in NAR’s most recent Survey of Mortgage Originators.

Operation Twist

In the wake of the great recession, the housing market hit historic lows with prices falling roughly 30 percent and home sales falling by more than half. To stimulate the economy, the Fed launched a new policy tool to buy government and private assets dubbed the large asset purchase program (LSAPs). In particular, the Fed began buying long-term Treasuries and agency (Fannie Mae, Freddie Mac, and Ginnie Mae) mortgage backs securities. The Fed’s final round of LSAPs, called “operation twist” was solely focused on buying long-term assets.

The rate on a mortgage is inversely related to its price, so the idea behind the program was for the Fed to buy and hold long-term mortgage debt, thereby driving up MBS prices and down mortgage rates. The plan worked and analysts estimate that mortgage rates fell 30 to 65 basis points as a result. By the end of the program, the Fed held roughly $4.5 trillion in Treasuries and agency MBS.

In late 2013, the then Fed Chairman Ben Bernanke ended the program, but the Fed held onto its massive stockpiles.  To prevent a jump in rates, the Fed bought new MBS and Treasuries with monies it received when loans in its stockpile of MBS were refinanced or repaid. In this way, the Fed was still an avid player in the market, even though it was just maintaining its $4.5 trillion in holdings.

At its peak, the Fed was buying roughly 77 percent of all agency MBS. Even after the Fed’s buying program ended, maintaining its massive holdings required it to buy up nearly a fifth of the market. While mortgage rates remain historically low, they have risen nearly 50 basis points from the lows of 2016. As a result, there are fewer persons for whom refinancing makes sense. The decline in refinancing means that the Fed has fewer dollars to reinvest each month and its role in the market has shrunk. At the same time, private demand for Treasuries and agency MBS has increased. Any further increase in private demand for these assets would help to moderate rate increases.

If It Isn’t Broken…

Why would the Fed end the program that is keeping mortgage rates low? In order to give itself room to respond to the next crisis.

The Fed’s purview is the entire banking system and all of the many industries it supports. In the next crisis, it may need to extend additional support. If the Fed has to repurchase $30 to $50 billion dollars of Treasuries and agency MBS each month, then it may be hamstrung and unable to provide that support. Furthermore, the Fed must be careful not to overstimulate a particular sector, thereby fomenting the next crisis. Allowing market forces to buy and sell these assets based on perceived risks and returns may curb any excess risk taking.

How Much Will Affordability Bite?

Academic research suggests that rates improved 30 to 65 basis points because of the Fed’s purchase program. If the Fed’s exit from the market were symmetric, one might expect an equal increase in rates. However, the Fed has indicated that it favors to end its reinvestment program and then to allow its stockpile of Treasuries and agency MBS to slowly decline over time as current homeowners refinance, pay off their mortgage, or sell their homes.

According to Freddie Mac, the current average rate for a 30-year fixed rate mortgage is 3.89 percent. Thus, rates might rise to between 4.19 percent and 4.49 percent…roughly the range they were at the begging of 2017. On a $200,000 mortgage that would cost an extra $35 to $42 each month. Affordability would fall, but sales did not moderate when rates reached this level in early 2017. Mortgage rates are expected to rise further, though, as economic growth solidifies and they could rise sharply if the President’s proposed tax cuts, infrastructure spending, and regulatory relief programs take hold.

What are Lenders Saying?

Lenders were asked about the end of the Fed’s reinvestment program and the potential impact on housing in NAR’s most recent Survey of Mortgage Originators. 28.6 percent of lenders felt that the change would cause rates to rise. An additional 42.9 percent indicated that rates would rise and become more volatile.  Only 7.1 percent thought that the change would not have an impact on rates.

reinvestment
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When asked about an end to the Fed’s reinvestment program, 40 percent of respondents thought the impact from the end of the FED’s reinvestment program would be felt in advance of implementation. However, 30 percent felt that the full impact would take 6 to 12 months to be absorbed and another 20 percent thought it would take up to two years. A 50 basis point increase to rates was the most frequently cited impact.

The Fed is about to end a program that has helped to keep mortgage rates low for several years. Mortgage rates are likely to rise as a result, but roughly in line with levels that the market has seen in recent months. However, mortgage rates are likely to rise further in the coming years weighing on affordability and with the Fed’s pullback, rates will become more volatile as market forces play a stronger role.

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Source: Economy

Copyright NATIONAL ASSOCIATION OF REALTORS®. Reprinted with permission.


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This Article Appears Courtesy of Steven Diadoo

Steven Diadoo, Licensed Realtor in MN with BRIDGE REALTY and best-selling author of 'Road to Success' with Jack Canfield (Chicken Soup for the Soul), Board Member at Bowling for Brains Non-Profit 501(c)3 (Event to benefit the American Brain Tumor Association), licensed Realtor with Bridge Realty, Seen on DIY TV, Create Channel and PBS. For help buying and/or selling a house, please call (952) 270-6141 or Click here.

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