Why The Federal Reserve Needs A Mortgage Diet

The stock market quivered last week when it was announced that the Federal Reserve had given thought in January to ending its purchase of mortgage-backed securities at some unknown point in the far distant future.

The Fed said it will continue its policy of purchasing about $40 billion in mortgage-backed securities each month into the distant future or until the 12th of Never, whichever comes first.

“If the outlook for the labor market does not improve substantially,” said the Fed, it “will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until such improvement is achieved in a context of price stability.”

The Fed MBS buying policy is pushing down interest rates and at the same time chasing away private-sector investors, the folks with capital. This may have been an appropriate strategy when the foreclosure crisis was at full throttle but that’s hardly the situation today, a time when the mortgage marketplace has become substantially less risky.

Fewer Foreclosures
Writing on Forbes.com, RealtyTrac Vice President Daren Blomquist explains that “75 percent of all loans that are actively in the foreclosure process were originated from 2004 to 2008, while only 14 percent were originated from 2009 to 2012, and only 11 percent were originated in 2003 or earlier.”

The RealtyTrac figures confirm the reality that tighter mortgage standards are producing measurable marketplace results. Prior to the mortgage meltdown the foreclosure rate was generally thought to be 0.4 percent. Now foreclosures are between 0.1 and 0.2 percent of the loans held by Fannie Mae and Freddie Mac, a remarkable reduction.

Given that mortgage loans are safer than in the recent past why should it be difficult to entice the purchase of mortgage-backed securities by private capital? Are the options elsewhere for investors really that good?

The Fed says that its MBS purchase policy will continue until the labor market improves but the writ of the Federal Reserve is to protect the banking system, no one would ever confuse it with the Labor Department. It either has to get out of the MBS purchase business or it will grow to such immense size that it will ensnare much of the capital marketplace.

It’s worth noting that the Fed is now so huge that it transferred $88.9 billion in profits back to the Treasury in January. That sum could fund the entire Department of Education — with enough left over to invade a small country.

Here’s a suggestion: The Fed should be on a $1 billion-a-month diet. Start now, surprise no one, spend $1 billion less each month on MBS purchases and in four years the Fed can gradually be out of the MBS business. And no snacking allowed.

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