Fed to Begin Purchasing Agency MBS in January
(Update 1: Adds in comments from Barclays Capital analysts) Let the quantitative easing roll forward -- the somewhat controversial policy, involving flooding markets with fresh money during times of economic distress, will directly push its way into the nation's secondary mortgage markets in January, according to a statement from the Federal Reserve late Tuesday. The Fed said it expects to begin operations in early January under a previously-announced program to purchase agency MBS, and that it had selected a group of private investment managers to run the program. The Fed had announced on Nov. 25 that it would initiate a program to purchase up to $100 billion GSE direct obligations and $500 billion MBS backed by Fannie Mae (FNM), Freddie Mac (FRE) and Ginnie Mae, in an effort to replace waning demand from foreign and other more traditional buyers of mortgage bonds. "The potential size of the Fed’s purchase program can take down most of the 2009 agency MBS net supply," analysts Derek Chen and Nicholas Strand at Barclays Capital said late Tuesday evening in a research report. Both Chen and Strand believe the Fed program will drive primary mortgage rates down to 4.5 percent, stimulating further refinancing activity, although a huge refi boom -- last seen in 2003 -- isn't likely without looser underwriting. BlackRock Inc. (BLK), Goldman Sachs Asset Management, PIMCO and Wellington Management Company, LLP were selected to manage the purchase transactions, characterized as a "buy and hold" operation by officials at the New York Fed. No word on what really got each firm a cut of the deal here, and the Fed said it was still searching for a custodian. Under the program, only fixed-rate agency MBS securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae are eligible assets for the program, including 30-year, 20-year and 15-year securities of these issuers. The program does not include CMOs, REMICs, Trust IOs/Trust POs and other mortgage derivatives or cash equivalents, a program information sheet said; the Fed will trade in specified pools, TBA transactions, and in the dollar roll market -- in other words, every nook and cranny of the agency MBS market. "Purchases will be financed through the creation of additional bank reserves," the Fed said, code-speak for printing more money. The question that should naturally be asked here is not if inflation concerns re-enter the economic picture, but when. The practice of "quantitative easing" is predicated on the idea that flooding markets with cash will entice at least some participants to deploy capital, rather than hoard it. But, as numerous market participants have already suggested, at some point all of that excess money supply comes full circle. MarketWatch’s Irwin Kellner is among those that believe the longer-term threat to the U.S. economy remains inflation. “While virtually no one is raising prices in today’s depressed economy, all this liquidity will soon become an accident looking for a place to happen,” he wrote in a recent column. “The trick then, for the Fed, is to drain this excess liquidity before it turns into inflation. “This is easier said than done, because the Fed will have to begin weaning us off easy money long before the recession ends. By the way, this could happen sooner than you think.” For now, however, the Fed is clearly content to print money to finance the purchase of government-backed mortgage assets -- which means, oddly enough, that the government is printing money in order to buy from the government. Both Fannie and Freddie are currently under federal conservatorship, while Ginnie Mae is itself a government agency. Read the NY Fed's FAQ on the MBS purchase program. Write to Paul Jackson at firstname.lastname@example.org. Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.