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

Dean Baker — Washington Post Pushes for Government Guaranteed Subprime Mortgage Backed Securities

The bulk of its lead editorialtouting the prospects for bipartisanship is focused on pushing the Johnson-Crapo bill, a measure that would replace Fannie Mae and Freddie Mac with a system whereby the government guarantees 90 percent of the value of privately issued mortgage backed securities (MBS). This means that Goldman Sachs, Citigroup and other folks who might issue MBS could now tell their customers that even in a worst case scenario they couldn't lose more than 10 percent of the value of their securities. 

Fans of the market should be asking two questions here. What problem is this intended to solve? And why do private issuers need a government guarantee?

More moral hazard and perverse incentives in FIRE.

Beat the Press
Washington Post Pushes for Government Guaranteed Subprime Mortgage Backed Securities

Dean Baker

Mike Whitney — The Economic Scam of the Century

This is such an outrageous, in-your-face ripoff, it shouldn’t even require a response. These jokers should be laughed out of the senate. All the same, the bill is moving forward, and President Twoface has thrown his weigh behind it. Is there sort of illicit, under-the-table, villainous activity this man won’t support?

Not when it comes to his big bank buddies, there isn’t.

Read the fine print. 

Incredible coming from the people that promised no more bailouts. Well, not really incredible at all considering who they are working for.

Counterpunch
The Economic Scam of the Century
Mike Whitney

Taxpayers "make" $25 bln on a mortgage sale??????

This came across the headlines today and it shows how misunderstood the whole “bailout” was and is.

WASHINGTON (CNNMoney) -- Treasury just scored a big win -- it got rid of one of its financial-crisis era portfolios of mortgage-backed securities and made a hefty $25 billion profit, the department announced Monday. Treasury bought $225 billion worth of mortgage-backed securities during the height of the financial crisis starting from October 2008 through December 2009. Some of those securities were backing up loans thought to be worthless, financial analysts reported at the time. But Treasury's portfolio was made up mostly of 30-year fixed rate mortgage backed securities were guaranteed by Fannie Mae or Freddie Mac, making them more valuable. Last March, Treasury started the process of selling those securities. The agency reported that the total of cash from the sales, the principal and interest paid taxpayers back $250 billion. However, if the mortgages behind those securities fail, taxpayers will still be on the hook, since federal housing giants guarantee the loans and taxpayers have been propping up Fannie Mae and Freddie Mac. Treasury heralded the profit, calling it a successful winddown of a useful program that helped the nation navigate the financial crisis. "The successful sale of these securities marks another important milestone in the wind down of the government's emergency financial crisis response efforts," said Assistant Secretary for Financial Markets Mary Miller in a statement.

When the Treasury purchased $225 bln of mortgage bonds during the crisis in 2008 and 2009, it was simply an exchange of MBS for cash deposits (reserves) in the banking system, right?

Now the Treasury sells back those same mortgage backed securities to those same investors for a “profit” of $25 bln. So what has happened? Those investors (taxpayers) LOST $25 bln on that trade. (They sold for $225 bln and bought them back for $250 bln.)

Yet the news is calling this a profit for taxpayers.

Crazy!!