A Strong Argument in Favor of Keeping Federal Entities Active

William Mills Agency recently covered the Federal Reserve Bank of Chicago’s 49th Annual Conference on Bank Structure and Competition. Here is a recap of major discussions at the conference. This is the 2nd of a three part series.

Fixed Rate Mortgages Depend on Securitization Availability: Federal Reserve Bank Conference: Part 2

Fixed rate mortgages could be at risk or would at least go up substantially in price if the government gets out of the securitization market, an economist said at the annual conference.

Liquidity of securitization markets is a key driver of the availability and popularity of fixed-rate mortgages, and therefore, has important effects on household portfolios, said James Vickery, senior economist at the Federal Reserve Bank of New York. “Our estimates based on recent experience indicate that the share of fixed-rate mortgages is 20 to 30 percent higher when lenders are easily able to securitize newly-originated mortgages.”

Borrowers have shown a strong preference for the 30-rate fixed mortgage (ones with no prepayment penalties) over adjustable rate mortgages or fixed rate mortgages of shorter maturities, Vickery said, adding that the 30-year fixed rate mortgage is a U.S. phenomenon.

If such loans become more difficult to securitize, their rates will rise sharply because lenders won’t want to accept the interest rate risk over such a long period, Vickery said. He pointed to the downfall of the savings and loan industry that was driven largely by investments in mortgages that were at 4-6 percent when prevailing interest rates were two to three times that amount.

This is a strong argument in favor of keeping a federal entity such as Fannie Mae or Freddie Mac (or both) active in order to continue to provide the liquidity for fixed-rate mortgages, according to Vickery. He added that private capital could fill in the void, but private sources are subject to freezes from capital providers, unlike sources such as Freddie Mae and Fannie Mac.

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