Here’s the $1.4 Trillion dollar question: How will the history books remember pandemic era monetary policy? Will they commend Chairman Jay Powell and team for acting boldly in the nation’s time of need, thus preventing economic calamity; or will they see reckless and haphazard stimulus measures that imperiled the nation’s finances for future generations and distorted financial outcomes for millions of people? My guess is the latter.
$1.4 Trillion. That is the cumulative value of mortgage backed securities bought by the Federal Reserve from March of 2020 to April of 2022. Taken by itself, $1.4 Trillion would rank as the 15th largest country in the world by GDP, ahead of Spain, Indonesia, and Switzerland. It is roughly twice the value of the 2022 Defense budget of $766B and 17x the $82B spent by the Department of Education on public school teacher salaries in 2022.
From the end of 2019 to mid 2022, mortgage debt outstanding in the US increased from $16 to $18.7 Trillion, for an increase of $2.7 Trillion. That means that the Fed bought more than half of all mortgage debt originated during that time period. Why did they do this? By entering the mortgage market as the largest buyer, the Fed artificially pushed up demand for mortgage debt, which lowered mortgage rates (rates move inversely to demand). By lowering mortgage rates, home buyers could afford more home per dollar of income, thus stimulating activity.
And boy, did it work! The 3% mortgage ignited a speculative boom the likes of which hadn’t been seen since the days of NINJA loans (No Income, No Job, No Assets). Horror stories of waived inspections, dozens of competing offers, and selling prices hundreds of thousands of dollars over asking price, had prospective homeowners pulling out their hair. The lowest mortgage rates in the country’s history caused home prices to increase 40% between 2020 and 2023, increased home sales to a 15-year high in 2021 and 2022, and perhaps more importantly, set off a refinancing boom in which $5.7 Trillion of mortgage debt was refinanced at rates below 4%. According to Redfin, 62% of mortgage holders have a rate below 4%, while 92% have a rate below 6%. The Fed’s stimulative policies during the pandemic caused virtually the entire mortgage base of the country to churn over and reset at generationally low rates.
The Fed’s suppression of mortgage rates may very well be the greatest government-orchestrated wealth transfer in the history of this country. Keep in mind that before 2009 the government never got involved in the mortgage market. They kept their finger off the scale and allowed the market to function during good times and bad. To contextualize the size of the stimulus, there are 126 million households in the United States, with an estimated 40% of those that are mortgage-free. The $1.4 Trillion applied to the 76 million mortgaged homes in the United States equates to $18,421 per household, meaning that those that held mortgages and were able to refinance or buy a home with artificially low rates received an imputed benefit of over $18k on average.
Was all of this necessary? While desperate times call for desperate measures, emergency responses should be temporary stopgaps to buy time to get to better days. Let’s not forget, these are 30-year FIXED rate mortgages, about as far removed from short-term emergency stopgaps as one can get. Why were there no eligibility requirements, or caps on dollar values? Should the Airbnb tycoon, with fifteen properties, be able to refinance all of their mortgages at the same rate as the nurse who is living paycheck to paycheck? Don’t blame the tycoon, who is just opportunistically taking what the government gives him. Any sane individual would do the same.
I worry that these stimulus measures, while well intentioned, were not well thought out and will have knock-on effects that will be felt for decades. Anybody with a mortgage is sitting on a substantial asset and a generational windfall, while those that do not own a home either by choice or necessity have fallen further and further behind. The 40% rise in home prices coupled with mortgage rates increasing from 3% to 7% has more than doubled the all-in cost of buying a home. Have incomes doubled since 2020? Hah! The median household income has gone from $68.7k in 2019 to $74.6k in 2022, an increase of 8.5%. The Fed has substantially widened the gulf between the haves and the have-nots in America. No wonder certain groups of people feel that they have been left behind by a system that favors asset owners over all others.
How can we fix this? Unfortunately the damage has largely been done, as the entire mortgage holding public refinanced their mortgages during the free money era of 2020-2022. However, we can try and enact changes that will improve outcomes going forward. First, the Fed should remove itself from the mortgage market as quickly as possible. Currently, they are allowing their mortgage backed securities to roll off their balance sheet as they mature, but it is happening at a trickle. During 2023, the Fed shrunk its MBS holdings from $2.6 to $2.4 Trillion, about half of the maximum $30B per month as dictated by their balance sheet policy. At this pace, it will take the Fed 12 years to completely eliminate their MBS holdings. They should at least sell incremental MBS to hit the $30B monthly cap, which will give them 7 years to get to zero.
Remember, the country survived for centuries without the Fed distorting the mortgage market. Second, there must be oversight of the Fed. They currently have unilateral power to roll out trillions in stimulus over the course of a weekend. Is it too much to ask to ask for a cost-benefit analysis of the requested stimulus and a study of the implications of the stimulus on the finances of the country? Third, independent of the Fed, there must be a decrease in red-tape for the building of single-family homes. Only an increase in supply will help restore the market to equilibrium. And, if developers prefer to build large scale apartment buildings, the government should offer incentives to combat this. Incentivizing single family home construction will lead to more supply, and will allow more people access to home-ownership, which is the backbone of the American Dream.
What do you think? Was the Fed’s mortgage policy a good or bad thing for the country?