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I'm not an expert but I'll try. The Federal Reserve is buying mortgage backed securities to keep the mortgage interest rates low. Those securities are the way
by YZF 14y ago
I'm not an expert but I'll try. The Federal Reserve is buying mortgage backed securities to keep the mortgage interest rates low. Those securities are the way that banks that give you a mortgage raise their money. The federal reserve is also trying to keep longer term interest rates lower by selling short term bonds and using the proceeds to buy long term bonds (operation Twist). The general idea is to spur economic activity by increasing the money supply. ( http://en.wikipedia.org/wiki/Quantitative_easing http://en.wikipedia.org/wiki/Quantitative_easing )
The most significant thing this signals, in my opinion, is the expectation that the economy will continue to do poorly in the short and medium term. People have equated these policies to pushing on a rope, the Fed can lower the rates but it can not force companies to take loans and higher risks.
As an individual you may be able to refinance your debt at a lower rate. As a company you may be able to borrow money at a lower rate. In the real world however (as someone involved in a business who just got a bank loan for 6%) this doesn't always work.
The stock market may go higher because lower rates make bonds a less attractive investment. The only problem is the bond market isn't as impacted because some people feel the Fed will not be able to continue maintaining lower yields due to inflation.
(EDITed with some more thoughts)
- deleted 14y ago[deleted]
- photon137 14y agoI'll add to this. Edit: consumer-level or corporate level credit won't be any cheaper - only a very specific type of credit, ie mortgages, would become cheaper still. As you've rightly pointed out, the Fed is targeting mortgage rates, and thus, home affordability. This is to support house prices and encourage construction-based spending in the economy. House-buying and construction have the biggest multipliers in terms of their knock-on effect on the economy. That's why the recession was so deep - and that's why a recovery can only truly be kick-started by making mortgages affordable. However, some big downside risks here: (a) The European crisis, obviously - although the politicians now seem to have come to their senses a little bit. (b) The credit burden on the US consumer - consumers are still quite leveraged and spending is still financed heavily by credit than by pure income. That will always cause blips to the economy (like oil-price induced inflation) to be magnified and will defeat what the Fed is trying to achieve. (c) Short-term commodity inflation risks - but given that WTI light crude is almost $20 below Brent crude, there already is a North American supply glut.
- smokeyj 14y agoDoes this mean the Fed owns a bunch of houses around the country? How exactly do they target mortgage rates?
- photon137 14y agoThey buy mortgage-backed securities in the secondary markets which, in simple terms, are bonds issued by securitization agencies (well, mostly by Fannie Mae and Freddie Mac in the residential mortgage area) to fund pools that buy and collect individual residential mortgages. The higher prices for MBSes leads to cheaper funding for such pools. If funding of mortgages is cheaper for banks and agencies, then they become cheaper for the borrowers as well. Even if you aren't buying a new home, you can refinance your existing mortgage at a lower rate.
- GrothingFash 14y agoSo the FED is basically printing money and giving it to Fannie Mae and Freddie Mac to lend out as cheap mortgages? Isn't this what caused the 2008 crisis in the first place?