Is The Fed Being Funny?

The Federal Reserve started buying up mortgage-backed securities in November, and then on March 18th expanded the size of the program to $1.25 Trillion by the end of the year. The total amount of residential mortgages outstanding is just under $11 Trillion, about half of which is held or backed by the GSE’s.

The actual mortgages held by the GSE’s is roughly $1.5 Trillion, with the remainder securitized and guaranteed. However, one would have to add in the paper backed by Ginnie Mae as well. The total amount of Fannie Mae (FNM), Freddie Mac (FRE) and Ginnie Mae paper outstanding is about $5 Trillion. The rest of the mortgages are either held as whole loans on the books of banks and S&L’s, or are in private label securitizations (where the really nasty toxic waste is).

So just using some back-of-the-envelope calculations, it looks like by the end of the year the Fed will own about one quarter of all the GSE-related paper outstanding. It also suggests that if the Fed were not buying up all this paper, the number of mortgages that could be made would be sharply lower than they already are.

There does not seem to be a lot of demand in the private sector for this paper. Given that home prices are still falling — and unemployment and delinquencies are still rising - one might worry about the credit risk the Fed is taking on. After all, historically the Fed invested in nothing but T-bills.

The Fed addressed the issue in its FAQ about the program (http://www.newyorkfed.org/markets/mbs_FAQ.HTML):

“Does the agency MBS program expose the Federal Reserve to increased risk of losses?

“Assets purchased under this program are fully guaranteed as to principal and interest by Fannie Mae, Freddie Mac, and Ginnie Mae, so the Federal Reserve’s exposure to the credit risk of the underlying mortgages is minimal.”

This is an absolute knee-slapper! Don’t worry - the paper is guaranteed by Fannie and Freddie. That is supposed to give us comfort?

They somehow neglect to mention that FNM and FRE happen to be on life support from the Treasury - to the tune of $200 billion each.

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