* Beyond timing of QE3, debate over which assets to target
* Economic benefits from MBS, but Treasury market bigger
* Debate could impact decision on asset sales in exit
By Jonathan Spicer and Ann Saphir
NEW YORK/SAN FRANCISCO, May 1 (Reuters) – Top Federal
Reserve officials are happy with the boost their asset purchases
are giving the housing market, suggesting mortgage bonds could
trump Treasuries when the U.S. central bank tinkers with its
bond-buying program.
While much of the public debate has focused on if and when
the Fed will cut back on its bond buys, more and more
policymakers are taking sides in the debate over which assets
the central bank should concentrate on.
No changes are expected when the Fed wraps up a two-day
policy meeting on Wednesday. Economists widely agree it will
continue with monthly purchases of $40 billion in
mortgage-backed securities (MBS) and $45 billion in Treasuries
in an all-out effort to spur borrowing, investing and hiring
across the United States.
But if some doves at the Fed have their way, the central
bank might trim its Treasuries purchases first if it decides to
start tapering stimulus. Similarly, the central bank could end
up holding MBS longer if and when it eventually decides it is
time to sell off some assets to shrink its balance sheet.
While some hawkish officials say improvements in housing
should lead the Fed to stand down on mortgage bonds, the dovish
officials have held sway on policy since the Great Recession.
Boston Federal Reserve Bank President Eric Rosengren is
among those who say near-record low mortgage rates and
rebounding home sales reflect the success of directing stimulus
toward housing, arguing if anything for more rather than less.
“I always take Rosengren’s views as mirroring those of the
Fed chairman … and the chairman has not made many concessions
to the hawks yet,” said Christopher Rupkey, New York-based chief
financial economist at Bank of Tokyo-Mitsubishi.
“MBS probably helps the housing market strengthen and maybe
it should be the last to be cut,” he said.
WORRIES ON MARKET FUNCTIONING
On the other side of the debate are a number of hawkish
policymakers, like Richmond Fed chief Jeffrey Lacker.
These officials object to the policy, in part, because they
do not think the Fed should aim to prop up a particular sector
of the economy. Funneling credit, they say, is the market’s job.
They also worry the Fed could become so dominant in the
agency mortgage market that investors would be scared off,
possibly raising borrowing costs and undermining the policy.
At $5.7 trillion this market of securities backed by Fannie
Mae, Freddie Mac, Ginnie Mae and the federal home loan banks is
not much more than half the size of the $10.9 trillion market
for Treasuries.
Simon Potter, who oversees trading at the central bank’s New
York headquarters, said in March that demand for MBS had not yet
overwhelmed supply. But he too warned of trouble if it ever did.
CRUX OF THE CRISIS
Arguably, purchasing MBS rather than Treasuries more
directly influences the economy through the rate Americans get
on mortgages.
Last week, the average 30-year fixed rate mortgage hit a
near record low of 3.4 percent, down from 3.55 percent when the
Fed launched its latest stimulus effort in September, according
to Freddie Mac. That cheap financing is having its effect:
housing starts breached the 1-million unit-rate mark in March
for the first time since mid-2008.
There is also a simple logic to stimulating housing. The
housing collapse hurt by destroying construction jobs and by
destroying household net worth and as a result spending.
Rekindling housing throws that negative cycle into reverse,
giving what San Francisco Fed chief John Williams has called an
“oomph” to the economy.
Housing investment was less than 3 percent of GDP in 2012,
but typically is about 5 percent, suggesting plenty of room for
growth; all housing services typically account for 18 percent of
GDP, above the 15 percent seen last year.
Williams credits Fed policies, including both MBS and
Treasury purchases, with helping to push mortgage rates down
about 1.5 percentage points since the Fed’s first mortgage-bond
purchases back in 2008, and notes that the decline has helped
boost home sales and puts money in consumers’ pockets by
trimming monthly mortgage payments.
“As far as getting the most bang for your buck going
forward,” said Andrew Szczurowski, an MBS portfolio manager at
Eaton Vance, “mortgage purchases are the more appropriate
transmission mechanism as there are still millions of borrowers
who sit in mortgages (well) above market rates.”
FED’S FRONT LINES
The central bank buys about a quarter of all coupon
Treasuries that are issued each month.
But the Fed has snapped up about half of all the newly
issued MBS since it resumed buying them in September. That
portion could rise, possibly imperiling markets, if refinancing
activity declines as the economy improves and borrowing costs
rise, dissuading people from refinancing and leaving the market
with a smaller supply of tradable securities.
To reduce that risk, the Fed focuses its buying on the most
plentiful securities, making a market malfunction an “unlikely”
prospect even if refinancing falls, New York Fed’s Potter said.
Potter oversees a group of traders and portfolio managers at
the New York Fed who are watching for signs the market is
buckling under the central bank’s demand.
They hold three meetings before 9:30 a.m. each week day,
sometimes with Fed policymakers calling in, to discuss overnight
news and the day’s buying plan before traders head back to their
computers to start bidding on bonds.
All the needed Treasuries are bought from dealers by 11 a.m.
while, in a neighboring room, the MBS are purchased over the
course of about 20 trades throughout the day.
So far “there seems to be little evidence” the buying is
sapping liquidity or straining either of the markets, Potter
told the Forecasters Club of New York in March.
Even so, a recent New York Fed poll of Wall Street banks
showed most expect the Fed to have stopped buying MBS by March
2014 even as it continues to buy some Treasuries.
The question of which of the securities are more efficacious
will also surface in the years ahead, when the central bank
might decide to shrink its balance sheet, now worth some $3.2
trillion, to a more normal size around $1 trillion.
Unlike Treasuries, MBS have monthly prepayments that could
help the Fed reach that goal sooner. That could convince
officials to buy more of them now and to not rush to sell them
off in the years ahead.
In addition, minutes of the Fed’s last meeting in March
showed several officials favored holding on to MBS, or selling
them only very slowly, to lessen any market disruption from
sales. Meaning, the Fed could be in the housing market longer
than many now anticipate.
(Additional reporting by Albert Duros; Editing by Tim Ahmann,
Mary Milliken and Leslie Gevirtz)
