In the Fed’s efforts to save the economy from the worst recession since the Great Depression of the 1920’s, the government and Federal Reserve, have delivered some rather innovative rescue techniques never tried before. Many experts believed that these techniques wouldn’t work because the problems were much too serious. However, to date, the results have been successful and the current recession ended in the late summer of 2009.
Currently, the Feds have said that the time has come for a second attempt; reversing the earlier rescue efforts already taken. These new efforts will almost surely demand more careful maneuvering than the first efforts that generated panic, flooded the financial system with excess liquidity and dropped interest rates to nearly zero.
Some critics of the new ideas say it’s too soon to do this and that it will take our currently fragile economic recovery back into a double-dip recession. Let’s hope they are wrong!
Nevertheless, the Feds are for this new program and have already begun to implement it. Many believe that these first efforts appear somewhat heavy-handed, particularly by suddenly ceasing the giant 15-month program that purchased mortgage-related securities. The Feds cut their purchases by 50% early last month and then ended them altogether on March 31st, 2010.
The Feds appear confident that investors are now prepared to take back their role of supporting the housing industry by buying mortgages. Let’s hope that they checked with prospective buyers before they made this decision.
Before the onset of the current financial crisis and freeze-up of credit, institutional investors, pension plans, banks, hedge funds, and numerous private investors were eager to buy mortgage-related securities. Banks and other lenders quickly divided their mortgages into various risk levels, set them up in packages, and sold them to eager global investors. When the problems exploded, the lenders who wrote the original mortgages couldn’t even find them.
Once the sub-prime mortgage market collapsed and losses skyrocketed, people quickly understood that lenders and investors actually didn’t know the value, or the risks of what were in those divided-up mortgage packages. The end result was a toxic label placed on anything related to mortgage investments and the financial system came to a complete stop. Major financial institutions, hedge funds, and investors had no idea about the value of the ‘toxic waste’ on their balance sheets, as there was absolutely no market for them at all. Not a buyer in sight worldwide!
At this point, the Feds stepped in with their giant mortgage purchase program. By the time that the Feds stopped the program, they had more than $1.2 trillion in these investments. Their purchases were mostly in mortgage-backed securities of the well documented new safer mortgages originating from Fannie Mae and Freddie Mac.
It may be too much to expect institutional investors to totally replace the Fed’s huge activity. Some estimate that the Feds have been buying 90% of all new mortgage-backed securities for some time now and, in the process, have become the major player in mortgage-backed investments globally. The Feds are earning about $50 billion per year from mortgage interest that homeowners are paying.
There is still a question about how much these investments are worth, especially since that the largest buyer has been the Federal Reserve who will no longer be in the market. There is also the question of what will happen to the future value if mortgage defaults and foreclosures still continue to escalate, and also when the Feds someday begin unload their holdings to recover their money.
Meanwhile, many experts think that mortgage rates will begin to rise once again with the end of the Fed’s support. This is also suggested when we see that the rate on 30-year mortgages jumped higher than 5% this week, after a lengthy period of time below that percentage.
Mortgage rates rising again might well be some short-term advantage for the housing industry as the important spring home-buying season begins. The rates rising could prompt potential buyers who have been waiting for even lower home prices to stop waiting and buy now before rates go up even higher.
Nevertheless, this may not happen, since the equally-important program of rebates for first-time home buyers is slated to come to an end by the close of April, 2010.