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Did the Federal Reserve's MBS purchase program lower mortgage rates?

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  • Diana Hancock
  • Wayne Passmore

Abstract

We employ empirical pricing models for mortgage-backed security (MBS) yields and for mortgage rates to measure deviations from normal market functioning in order to assess how the Federal Reserve MBS purchase program--a 16 month program announced on November 25, 2008 and completed on March 31, 2010--affected risk premiums that were embedded in mortgage and swap markets. Our pricing models suggest that the announcement of the program, which signaled strong and credible government backing for mortgage markets in particular and for the financial system more generally, reduced mortgage rates by about 85 basis points between November 25 and December 31, 2008, even though no MBS had (yet) been purchased by the Federal Reserve ; Once the Federal Reserve's MBS program started purchasing MBS, we estimate that the abnormal risk premiums embedded mortgage rates decreased roughly 50 basis points. However, observed mortgage rates declined only slightly because of generally rising interest rates. ; After May 27, 2009 fairly normal pricing conditions existed in U.S. primary and secondary mortgage markets; that is, the relationship between mortgage rates and its determinants was similar to that observed prior to the financial crisis. After the end of the Federal Reserve's MBS purchase program on March 31, 2010, mortgage rates and interest rates more generally were significantly less than they had been at the beginning. ; In sum, we estimate that the Federal Reserve's MBS purchase program removed substantial risk premiums embedded in mortgage rates because of the financial crisis. The Federal Reserve also re-established a robust secondary mortgage market, which meant that the marginal mortgage borrower was funded by the capital markets and not directly by the banks during the financial crisis-had bank funding been the only source of funds, primary mortgage rates would have been much higher. ; Lastly, many observers have attributed part of the Federal Reserve's effect from purchasing MBS to portfolio rebalancing. We find that if portfolio rebalancing had a substantial effect, it may have had its greatest importance only after the Federal Reserve's purchases ended, but while the Federal Reserve held a substantial portion of the stock of outstanding MBS.

Suggested Citation

  • Diana Hancock & Wayne Passmore, 2011. "Did the Federal Reserve's MBS purchase program lower mortgage rates?," Finance and Economics Discussion Series 2011-01, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgfe:2011-01
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    References listed on IDEAS

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    1. Heuson, Andrea & Passmore, Wayne & Sparks, Roger, 2001. "Credit Scoring and Mortgage Securitization: Implications for Mortgage Rates and Credit Availability," The Journal of Real Estate Finance and Economics, Springer, vol. 23(3), pages 337-363, November.
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    4. Andreas Fuster & Paul S. Willen, 2010. "$1.25 Trillion is still real money : some facts about the effects of the Federal Reserve’s mortgage market investments," Public Policy Discussion Paper 10-4, Federal Reserve Bank of Boston.
    5. Diana Hancock & Wayne Passmore, 2010. "An analysis of government guarantees and the functioning of asset-backed securities markets," Finance and Economics Discussion Series 2010-46, Board of Governors of the Federal Reserve System (U.S.).
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    8. Roberto Perli & Brian P. Sack, 2003. "Does mortgage hedging amplify movements in long-term interest rates?," Finance and Economics Discussion Series 2003-49, Board of Governors of the Federal Reserve System (U.S.).
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    Keywords

    Mortgage-backed securities ; Housing policy ; Secondary mortgage market ; Mortgage loans ; Monetary policy;

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