How the Fed’s 2008 Mortgage Experiment Fueled Today’s Housing Crisis

As the largest investor in residential mortgage-backed securities (MBS) in the world, the Federal Reserve’s track record as an investor in this area is worth assessing – and, in my opinion, it’s a failing grade.

The Fed’s COVID-Era Intervention Fueled a Real Estate Bubble

The Fed’s intervention in the mortgage market, particularly in the COVID era, fueled a second real estate bubble that cost the Fed over $400 billion in losses on its MBS investments. The bubble ended when the Fed stopped purchasing MBS and raised rates to fight inflation. While time will tell whether recent increases in home prices are reversed, the Fed’s experiment has already had a significant impact.

A Radical Policy Response: Direct Intervention

From 1913 until 2008, the Fed owned zero mortgage-backed securities. However, this changed following the 2008 financial crisis, when the Fed began intervening directly in the mortgage market. Through a series of MBS purchases, the Fed’s MBS portfolio ballooned to $1.77 trillion by August 2017. While the Fed subsequently altered policy and slowly reduced its MBS holdings, the COVID crisis saw the Fed resume purchasing MBS – eventually owning $2.7 trillion in MBS when it stopped its purchases in the spring of 2022.

The Impact of Mortgage Interest Rates

The Fed’s MBS purchases coincided with large reductions in mortgage interest rates. For example, during the Fed’s COVID MBS purchase campaign, the national average 30-year mortgage interest rate fell to a low of 2.65% in January 2021. However, with the Fed’s campaign of higher interest rates to battle inflation, 30-year mortgage interest rates are hovering around 7% today. This change in the mortgage interest rate alone would cause monthly principal and interest payments on a same-sized mortgage loan to increase by 65%.

Predictably, the decline in mortgage interest rates stimulated housing demand and pushed home prices. From January 2018 to January 2022, government statistics report that the median new home price in the United States rose from $331,800 to $467,700 – an increase of 41%. Interestingly, from January 2018 through March 2020, before the Fed renewed its MBS purchases, the median price of a new house declined to $322,600. From April onwards, the national…

Related Facts

• The Fed’s MBS purchases and interest rate lowering following the 2008 financial crisis also fueled the first real estate bubble of the 21st century.
• The COVID-era housing boom saw bidding wars and record-high home prices, leading to concerns about an affordability crisis.
• The Federal Reserve’s $4.5 trillion balance sheet includes holdings of Treasury securities, MBS, and other assets.

Key Takeaway

The Federal Reserve’s MBS purchases and manipulation of interest rates have had far-reaching consequences in the housing market, contributing to both the first and second bubbles of the 21st century. While the Fed may argue that its actions were an attempt to support the economy and stabilize markets, the reality is that these interventions have long-term implications that are difficult to predict and may create more problems than they solve.

Conclusion

Congress should consider the impact of the Federal Reserve’s track record as an MBS investor and assess whether such policies should be continued. The Fed’s 2008 mortgage experiment was a radical departure from its historical practices and has contributed to the current housing crisis. As the world’s largest investor in MBS, the Fed’s actions carry significant risks and raise important questions about its role in the economy and the housing market.