An Agency Problem in the MBS Market and the Solicited Refinancing Channel of Large-Scale Asset Purchases

FEDS Working Paper No. 2015-027

http://dx.doi.org/10.17016/FEDS.2015.027

50 Pages Posted: 9 May 2015

See all articles by John Kandrac

John Kandrac

Board of Governors of the Federal Reserve System

Bernd Schlusche

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: March 4, 2015

Abstract

In this paper, we document that mortgage-backed securities (MBS) held by the Federal Reserve exhibit faster principal prepayment rates than MBS held by the rest of the market. Next, we show that this stylized fact persists even when controlling for factors that affect prepayment behavior, and thus determine the MBS that are delivered to the Federal Reserve. After ruling out several potential explanations for this result, we provide evidence that points to an agency problem in the secondary market for MBS, which has not previously been documented, as the most likely explanation for the abnormal prepayment behavior of Federal Reserve-held MBS. This agency problem -- a key feature of the MBS market -- arises when originators of mortgages that underlie the MBS no longer share in the prepayment risk of the securities, thereby increasing incentives to solicit refinancing activity. Therefore, Federal Reserve MBS holdings acquired from originators as a result of large-scale asset purchases can help stimulate economic activity through a so-called "solicited refinancing channel." Finally, we provide an estimate of the additional refinancing activity resulting from the solicited refinancing channel in the years after the Federal Reserve's first MBS purchase program, demonstrating that this channel conveyed savings on monthly mortgage payments to homeowners.

Keywords: Federal Reserve, LSAP, Monetary policy, QE, mortgage, mortgage-backed securities, prepayment rates

JEL Classification: E52, G01, G21, R38

Suggested Citation

Kandrac, John and Schlusche, Bernd, An Agency Problem in the MBS Market and the Solicited Refinancing Channel of Large-Scale Asset Purchases (March 4, 2015). http://dx.doi.org/10.17016/FEDS.2015.027. Available at SSRN: https://ssrn.com/abstract=2604143 or http://dx.doi.org/10.2139/ssrn.2604143

John Kandrac

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Bernd Schlusche (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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