Tuesday, July 11, 2017

Liberty Street — How the Fed Changes the Size of Its Balance Sheet: The Case of Mortgage-Backed Securities

In our previous post, we considered balance sheet mechanics related to the Federal Reserve’s purchase and redemption of Treasury securities. These mechanics are fairly straightforward and help to illustrate the basic relationships among actors in the financial system. Here, we turn to transactions involving agency mortgage-backed securities (MBS), which are somewhat more complicated. We focus particularly on what happens when households pay down their mortgages, either through regular monthly amortizations or a large payment covering some or all of the outstanding balance, as might occur with a refinancing.

As we did in our previous post, we start with a set of simplified balance sheets, shown in the next exhibit. Three of the balance sheets are for the same actors as before: the Fed, the banking sector, and the public.

We replace the balance sheet of the Treasury, which we won’t need to look at, with the balance sheet of an issuer of MBS. The MBS issuer could be one of two government-sponsored enterprises—Fannie Mae and Freddie Mac—or the government corporation Ginnie Mae. All three are agencies that guarantee the MBS into which individual mortgages are pooled. For simplicity, we will refer to these institutions as “MBS issuers” in this post. 
FRBNY — Liberty Street Economics
How the Fed Changes the Size of Its Balance Sheet: The Case of Mortgage-Backed SecuritiesDeborah Leonard, Antoine Martin, Simon Potter, and Brett Rose

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