One of the programs put into effect during the mortgage financial crisis was Quantitative Easing(“QE”). There were three QE phases. The objective of this program was to provide liquidity and support to the capital markets, including the agency mortgage-backed securities (MBS) market.
The Federal Reserve used its balance sheet to house MBS and U.S. Treasury securities that were purchased. Since 2008, the Fed has added over $3.5 trillion of securities to its balance sheet - up more than 5X to approximately $4.4 trillion.
Since September 2017, the Fed has implemented a “normalization” program to begin unwinding these holdings in a steady, measured and disciplined manner.
Prior to the financial crisis, the Fed held no agency MBS.
As the Quantitative Easing programs commenced, the Fed eventually built up a portfolio of approximately $1.78 trillion in agency MBS.
And since commencement of the “normalization” program at the start of Q4 2017, the MBS holdings have fallen by $101 billion, or 5.6%.
As a result of the quantitative easing programs, the Fed owned at its peak approximately 32 percent of outstanding agency MBS.
And since “normalization” commenced, the Fed’s market share of agency MBS has fallen to 28 percent.
While the Fed’s holdings and market share of outstanding agency MBS is significant, its share of purchases of new agency MBS issuance over time is also quite relevant.
When the Quantitative Easing programs started, the Fed was purchasing over 40 percent of the agency MBS issued. Initially moving into the agency MBS market in a big way to quickly bring support and liquidity. Over time, this market share fell to below 30 percent.
And over the past several months, the Fed’s share of agency MBS issuance has fallen to approximately 5 to 10 percent of monthly issuance.
The Fed has been significantly decreasing its presence in the agency MBS market. And, as the Fed moves out, the agency MBS market appears vibrant, resilient and liquid today.
Two other questions of note are:
Can the agency MBS market withstand the pull back of such a major market participant that the Federal Reserve has been since 2008? It would appear that the agency MBS market has the fundamentals necessary - and is doing it.
As the Fed more significantly reduces its 28 percent share of outstanding agency MBS, which investors will step up to purchase these single-family residential mortgage assets? It appears that, in the near term, banks and thrifts have stepped up and added to their holdings. But can banks and thrifts pick up another $0.8 to $1.7 trillion in MBS? If not, what other investors will step up?
The Federal Reserve continues its balance sheet “normalization” program and intends to reduce its holdings of agency MBS materially. Agency MBS held by the Fed are expected to drop by at least 50% - and there is a possibility that this could be reduced to zero (“U.S. Treasury”-only balance sheet).
So far, there has been almost no impact on the market for agency MBS. However, over time, this will remain an important issue to monitor with ramifications for the housing sector, homeownership, housing prices, mortgage financing costs and GSE reform.
For more information on the Fed’s activities, please go to BankingStrategist.