The Federal Reserve is stepping away from purchasing mortgage-backed securities — a move that has helped keep mortgage rates low. While the move might sound like it could lead to rates going up, some industry experts say the shift, which marks a major change in housing finance policy, could pave the way for more affordable mortgages if Fannie Mae and Freddie Mac step in to buy more home loans.
Mortgage-backed securities, or MBS, are bundles of home loans that banks and lenders group together and sell to investors like banks, pension funds or even the Fed. Mortgage-backed securities are typically issued by government-backed entities like Fannie Mae, Freddie Mac and Ginni Mae, which guarantee payments to investors.
For years, the central bank has played a behind-the-scenes role in keeping mortgage rates low by purchasing trillions of dollars' worth of mortgage-backed securities, especially in response to the 2008 financial crisis and again during the pandemic to support the housing market.
Now, the Federal Reserve is making a big change. Chairman Jerome Powell announced starting in December, the Fed will stop reinvesting in mortgage-backed securities, a step to non-emergency monetary policy after years of extraordinary support for the housing market.
Instead of putting money back into home loans, the Fed will now purchase short-term government bonds known as Treasury bills. This marks a major shift in how mortgage rates have been supported and raises the question of what’s next for the mortgage market.
That’s where Fannie and Freddie could step in. Strategists at Morgan Stanley argue that both government-controlled entities could play a bigger role in keeping mortgage rates more affordable. They explain that if both entities increase their purchases of mortgage-backed securities, it will boost demand for these investments. Higher demand typically leads to lower yields and tighter spreads, which translates into lower mortgage rates for consumers, making it easier and more affordable to buy a home or refinance.
Additionally, the strategists detailed that Fannie and Freddie have room to expand their mortgage holdings, which could help lower mortgage rates if they choose to buy more mortgages. After the financial crisis, the government limited how much both entities could hold in their investment portfolios, which are set at $225 billion each.
Data from Bank of America shows that Fannie Mae’s portfolio is $98.7 billion, and Freddie Mac’s is $116.4 billion, both well below their respective caps, giving them significant room to add more mortgage-backed securities if they’re allowed to do so.
Meanwhile, the Federal Housing Finance Agency raised the limit on how much Freddie Mac can invest in home loans during the third quarter, allowing the entity to buy up to $40 billion worth of single-family mortgages.
Yet, some are skeptical. “My expectation would be they will not be allowed to build [their portfolios] up again,” Clifford Rossi, professor at the University of Maryland Smith School of Business, told Homes.com in an interview. “Well, who knows with this administration, they might.”
Fannie Mae and Freddie Mac did not immediately respond to a request to comment.
However, some Wall Street strategists see things differently. According to Bank of America, both Fannie and Freddie have been gradually increasing their portfolios, with recent months showing notable purchases. Unlike the Fed, which would require a policy shift, both government-controlled entities could ramp up buying mortgage-backed securities right away if directed.
“That said, we may be in the minority in saying we do not think the GSEs [government-sponsored enterprises] should revert to being the next backstop buyer. Instead, we believe this role is better suited for the Fed,” Jeana Curro, a mortgage-backed securities strategist at Bank of America, wrote in a note.
Curro added that Fannie and Freddie’s involvement “serving as a backstop buyer complicates their prospects for an eventual IPO or Conservatorship Exit — both of which the Administration would seemingly like to do.”