Agency MBS: How The Fed Buying MBS Helps You
Kevin Graham6-minute read
May 26, 2021
The Federal Reserve has committed to using every tool in its toolbelt in order to support the economy in its recovery from COVID-19. One of the strategies the Fed has undertaken involves buying $40 million worth of mortgage-backed securities (MBS) per month. Specifically, the Fed is buying what are known as agency MBS.
In this article, we’ll go over how it all works, the precedent for the current policies, and what it all means for those looking to apply for a mortgage.
Agency MBS Definition
Before we get to agency MBS, we should probably give an overview of what mortgage-backed securities are.
Sold in the bond market, a mortgage-backed security is created when loans with similar terms and characteristics are packaged and sold to investors. Investors make money on the principal and interest payments made throughout the life of the loans. Rising and falling demand for MBS is a major determinant for mortgage rates, along with borrower qualification characteristics.
A hypothetical MBS might contain loans from Freddie Mac with borrowers who have 680+ median FICO® Scores and made 20% down payments for 1-unit primary homes. It’s not uncommon for a single MBS to contain 1,000 loans or more.
One of the goals of the Fed is to support consumer borrowing and the free flow of credit in the economy with the goal of supporting the post-pandemic recovery. To that end, the Federal Reserve has been buying a ton of agency MBS.
Agency MBS are mortgage-backed securities issued by the government-sponsored enterprises Freddie Mac and Fannie Mae, or the U.S. government agency Ginnie Mae in order to keep mortgage rates low and homeownership accessible.
Fannie Mae and Freddie Mac are the major backers of conventional loans. Ginnie Mae is the entity that packages loans backed directly by the federal government, such as FHA and VA loans, for sale to investors.
According to the Urban Institute, as of November 2020, agency MBS made up 97.27% of the residential mortgage market. As the largest buyer and holder of agency MBS, the Fed is able to keep its thumb on mortgage rates. We’ll get into the mechanics of why later on, but at a high-level, because the Fed has inflated demand for agency MBS, mortgage rates are kept low.
Agency MBS Vs. Non-Agency MBS
Agency MBS are underwritten to the strict standards of Fannie Mae, Freddie Mac, the FHA, USDA and VA. The agencies offer various options like fixed- and adjustable-rate mortgages (ARMs) and numerous term lengths.
Non-agency MBS back other loan options that serve a variety of purposes. These could be the higher loan amounts necessitated by jumbo loans. They may also be used to help fund a mortgage market for borrowers with less than stellar credit. Interest-only loans would also be included in a non-agency MBS.
The distinction between agency and non-agency MBS came into sharp relief during the 2008 financial crisis. There were many lenders who were using lax underwriting standards to approve mortgages for borrowers who in normal times might not qualify. This led to a housing bubble and an economic crisis when that bubble burst, leading many into foreclosure.
Non-agency loans for the purposes listed above still do exist today, but strict regulations are enforced regarding qualification. As the numbers bear out, most Americans end up getting agency loans.
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How Agency MBS Purchases Work
Mortgage rates as consumers know it are based on two things: your personal qualifying characteristics and the overall market appetite for MBS. To truly understand how this all works, let’s run through an overview of the market as well as discuss how and why it’s so important to the Fed.
We went over at a high-level how mortgage-backed securities are grouped earlier and on the face of it, much of it comes down to personal characteristics. As an example, the higher your credit score and the higher your down payment, the lower the risk is for the lender and thus for the investor in the bond. Additionally, primary properties present a lower risk because if you experience a financial hardship, you’re more likely to make a payment on a primary property than one for vacation home or rental.
If there’s a lower risk associated with the loans underlying a certain MBS, an investor will be willing to accept a lower yield which means a lower rate from the borrower. Clients whose mortgages fall into bonds that fall into various levels of higher risk end up with proportionally higher rates.
However, a lot of this is also about the market appetite for bonds. Speaking generally, if consumers feel that the economy is headed for a period of struggle, they’ll push their money into bonds because there’s a guaranteed return. There’s a low level of risk as long as the yield manages to outpace inflation.
If people see good times ahead, they’re more likely to pull the money out of bonds and put it into more speculative investments like stocks. While these are riskier, they offer a higher rate of return.
Because the Federal Reserve is buying billions in mortgage bonds every month, this raises demand in the agency MBS market. In turn, yields on those bonds can be lower and still attract a buyer, which has a direct effect leading to lower rates.
The Federal Reserve has a big interest in making sure that the housing market is stable, and that affordable housing is supported through low rates because the residential home market accounts for a huge percentage of overall economic growth. Drawing from figures from the Bureau of Economic Analysis, one calculation of housing’s contribution to overall gross domestic product from the National Association of Home Builders was between 15% – 18% annually, depending on the year.
After the 2008 financial crisis, there was a lack of interest in mortgage bonds given the crash. This threatened to make getting financial support for housing very difficult. Given this, the Fed stepped in to provide liquidity.
Agency MBS, A History
In the aftermath of the crisis, Fannie Mae and Freddie Mac came under government conservatorship and new regulations were passed in order to prevent problems of a similar magnitude in the future. Around this time, the Fed also began purchasing agency MBS to provide liquidity and stabilize rates, with the goal of keeping home financing affordable for the average American.
Agency MBS was a natural target for purchase for a couple of reasons. The most obvious is that as we saw earlier, agency MBS cover the vast majority of the home loans made on the market, so you can make the greatest impact on the greatest number of home buyers by buying agency MBS.
Second, there were various protections put in place during and after the financial crisis that make agency MBS a less-risky investment for the Federal Reserve and the American taxpayer. There are stricter underwriting standards. Additionally, if you find yourself in financial trouble, there are increased options for forbearance and other measures that can be taken to help you get back on track and stay in your home. This is in addition to consumer protection laws that have been passed.
In mid-March of last year, COVID-19 hit U.S. shores. The pandemic has had far-reaching effects across society in general, but the economic effects are particularly acute. In order to make sure that consumers still had access to credit and borrowing necessary for their future and the support of the national economy as a whole, the Federal Reserve dusted off the playbook from 2008.
In addition to slashing interest rates on short-term overnight bank borrowing to near zero, the Federal Reserve immediately voted to increase holdings of agency MBS by at least $200 billion before voting shortly thereafter to buy $40 million worth of MBS.
This has largely had the effect that the Fed intended. Freddie Mac puts out a weekly survey of conventional loan rates from a sample of lenders across the country. The rate is for clients who have put down a 20% down payment and paid a certain number of mortgage points.
On March 19, 2020, a date after the Federal Reserve made its announcement of support for the market but before the impact would’ve been felt in the survey, the rate for a 30-year fixed mortgage with 0.7 points paid was 3.65%. The current rate with the same number of points paid in last week’s survey was 2.94%. Moreover, on Christmas Eve of last year, the rate dipped as low as 2.66%.
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The Bottom Line: The 2008 Housing Crisis Prepared The Fed To Protect Homeowners From A COVID-19 Crash
If there’s one take away you should have from this article, it’s that mortgage rates as they stand now are much lower than they would be without the intervention of the Federal Reserve. It’s also not inaccurate to say that many of the strategies employed during 2008 are being employed to support the economy during the recovery from the impact of COVID-19.
The Fed targeted agency MBS because the loans underlying the securities make up the majority of the market for housing. By buying into that market, it’s able to create a huge source of demand for those bonds, pushing down yields and rates.
For more info on efforts at relief and other articles on making it through this difficult time, check out our COVID-19 Resource Guide. Among other topics, there’s more info on government-backed options to prevent foreclosure. If you’re struggling, we encourage you to check out the alternatives available to provide mortgage help.
Are you just looking to take advantage of low rates to buy or refinance a home? You can apply online! If you’d rather get started over the phone, you can call us at (833) 326-6018.
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