Did the Federal Reserve’s MBS Purchase Program Lower Mortgage Rates?

62 Pages Posted: 10 Nov 2011

See all articles by Diana Hancock

Diana Hancock

Federal Reserve Board - Division of Research and Statistics

S. Wayne Passmore

Board of Governors of the Federal Reserve - Household and Real Estate Finance Section

Date Written: December 10, 2010

Abstract

We employ empirical pricing models for mortgage-backed security (MBS) yields and for mortgage rates to measure deviations from normal market functioning in order to assess how the Federal Reserve MBS purchase program -- a 16 month program announced on November 25, 2008 and completed on March 31, 2010 -- affected risk premiums that were embedded in mortgage and swap markets. Our pricing models suggest that the announcement of the program, which signaled strong and credible government backing for mortgage markets in particular and for the financial system more generally, reduced mortgage rates by about 85 basis points between November 25 and December 31, 2008, even though no MBS had (yet) been purchased by the Federal Reserve. Once the Federal Reserve's MBS program started purchasing MBS, we estimate that abnormal risk premiums embedded mortgage rates decreased roughly 50 basis points. After May 27, 2009, fairly normal pricing conditions existed in U.S. primary and secondary mortgage markets; that is, the relationship between mortgage rates and its determinants was similar to that observed prior to the financial crisis. After the end of the Federal Reserve's MBS purchase program on March 31, 2010, mortgage rates and interest rates more generally were significantly less than they had been on November 25. 2008. Many observers have attributed part of the Federal Reserve's effect from purchasing MBS to portfolio rebalancing. We find that if portfolio rebalancing had a substantial effect, it may have had its greatest importance only after the Federal Reserve's purchases ended, but while the Federal Reserve held a substantial portion of the stock of outstanding MBS. In sum, during the finanical crisis, the Federal Reserve's MBS purchase program removed substantial risk premiums embedded in mortgage rates and re-established a robust secondary mortgage market.

Keywords: Federal Reserve, mortgage-backed securities, MBS, mortgage rate, quantitative easing

JEL Classification: G01, E44

Suggested Citation

Hancock, Diana and Passmore, Stuart Wayne, Did the Federal Reserve’s MBS Purchase Program Lower Mortgage Rates? (December 10, 2010). FEDS Working Paper No. 2011-01, Available at SSRN: https://ssrn.com/abstract=1957380 or http://dx.doi.org/10.2139/ssrn.1957380

Diana Hancock (Contact Author)

Federal Reserve Board - Division of Research and Statistics ( email )

20th & C. St., N.W.
Washington, DC 20551
United States
202-452-3019 (Phone)
202-452-5295 (Fax)

Stuart Wayne Passmore

Board of Governors of the Federal Reserve - Household and Real Estate Finance Section ( email )

Washington, DC 20551
United States
202-452-6432 (Phone)
202-452-3819 (Fax)

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