As the Fed sees it, keeping mortgage rates low is essential to a housing recovery. Unfortunately, mortgage loan supply completely dried up, which could have significantly raised mortgage rates, until the Fed stepped in. Now the Fed and government-sponsored entities are buying up every mortgage in sight. This is the main reason rates are low and any loans are being made at all.
The Fed’s program to purchase MBS’s is set to end in March. Obviously, the Fed wants to end this program with as little noise as possible, so it is looking for substitute buyers. Foreign sovereign wealth funds have apparently been targeted as potential buyers since their countries have a vested interest in US stability. The problem is that the fund managers also have a vested interest to make a profit, and with the Fed’s exit most fund managers are fleeing the MBS market.
Compounding this problem is China’s recent announcement to divest some of its riskier US holdings. In fact, China recently sold about $34 billion in US Treasuries, so China does not appear to have the appetite to replace the Fed.
Some buyers may step in, but not likely to the same extent as the Fed…unless the deal can be sweetened.
Either way, it feels like mortgage rates in the US will rise, reducing housing demand. Reduced housing demand will put pressure on home prices and increase foreclosures. Of course, this trickles through to bank balance sheets as good assets become bad. The real unknown is to what degree does this all happen? Or is there enough momentum in the economy to offset the indirect subsidy provided by the Fed?
