Thursday, August 13, 2009

FED WINDING DOWN MORTGAGE PURCHASES

The Federal Reserve announced today that it will wind down a program to purchase up to $1.25 trillion in mortgage-backed securities by the end of the year, removing a significant backstop to higher mortgage rates.

In conversation after conversation with buyers this summer, I have emphasized that there are three key drivers pushing buyers into the market below $250,000:

1) the $8,000 first-time buyers tax credit, scheduled to end November 30
2) more affordable prices for entry-level homes, since 80% of Colorado's foreclosures (and subsequent value losses) have hit homes priced at $250,000 and below
3) 30-year fixed interest rates in the 5's, which are historic, and in my view, temporary

One analogy I use is that our national economy has suffered a heart attack, and the government has been doing fast and furious CPR for the past year in an attempt to revive it.

This "CPR" has taken the form of the banking bailouts, the stimulus bill, the first-time buyer tax credit, and in a lesser known development, the decision to purchase massive amounts of newly financed mortgages at discounted rates.

Because most institutional investors who formerly purchased mortgage-backed securities have been pulverized by foreclosure-driven losses, there has been very little demand from the private sector for mortgage-backed investments. So into that void stepped the federal government, with its decision to purchase $1.25 trillion in mortgage loans at a time when no one else wanted to take on the risk.

If the Fed stops buying mortgages at the end of the year, who will step into the gap?

What the market has shown is that private investors will demand a greater return for the risk involved in purchasing bundled mortgages.

So what does that mean? It means the pressure for higher mortgage rates is building, which is why taking advantage of today's low rates is so important.