By The past several months seem to prove that you shouldn’t always trust conventional wisdom. Most recently, conventional wisdom was that in March, the Federal Reserve would have finished buying the $1.25 trillion in mortgage backed securities they were authorized to purchase, and when this heavy buying activity ended, mortgage rates would shoot up in April, May and June.
It was simple economics. If the Fed was in there every day buying up mortgage securities, this heavy buying would drive MBS prices up and rates would go down.
This did work, and the low rates were precisely what the Administration hoped would happen to get the housing market back on its feet.
The 800 pound gorilla was the fear of what would happen when all this buying activity by the Fed ended.
Basic economics would seem to indicate that rates would have gone up and perhaps significantly.
Even worse was what would happen when the Fed started selling these securities. If they were to dump even a few billion a day, the constant selling would drive MBS prices down and mortgage rates up.
Almost everyone predicted this scenario, and many housing economists thought it would be devastating to the housing markets.
But in an economy with so many moving parts, things often turn out differently than expected.
Rates not only didn’t go up, they’ve actually gone down, and this has huge implications.
With rates dropping toward 4.5%, we are seeing a whole new wave of refinancing, and many of these loans being refinanced are in mortgage securities owned by the Fed! As a result, this $1.25 trillion in MBS the Fed owns is gradually being paid off on its own. And the more people re-finance, the more will be paid down.
The implications of this are huge. If the $1.25 trillion pays down through refinance activity to, say, $750 billion, that could open up the Fed to buying another $500 billion to get back to the $1.25 trillion number.
If you think about it, a new round of Fed buying, as they replenish their holdings, could drive rates to a level no one could have ever dreamed of.
As hard as it is to imagine rates being as low as 4.5%, a new round of Fed purchases could drive rates to 4.0% or even lower.
As Yogi Berra once said, “Who’d have ever thunk it?”
Indeed.
