America’s mortgage mess made simple

Stuff in the news: the U.S. Federal Reserve Bank (central bank) is going to stop buying bonds that are backed by mortgages sometime in March.

Since the start of the financial crisis, the U.S. Fed has bought about $1.1 trillion of these (maybe 14% 9% of all the mortgage money outstanding in America. Trillion is 1 times 10 to the 12th here.) The Fed did it to keep American mortgage rates from going through the roof. (If no one was there to put money into the mortgage market, it most likely would have shut down entirely — seeing as how even major companies weren’t being fully trusted to pay back until 2009 wore on.)

So when you hear people gripe about the Fed’s “printing press” and “all the money they created”, this is where it all came from. When the Fed buys anything, the check it writes is automatically good. There is no need for a deposit; the money comes out of thin air.

Just to note: prior to the international financial mess, the U.S. Fed was holding onto maybe $800 billion of bonds, almost all U.S. Treasuries (government bonds). They picked up the 1.1 trillion after that, as well as certain AIG and Bear Stearns (?) debt. They are at about a $2.2 trillion balance sheet now. Of which the $1.1 trillion is the big fish.

The problem, of course, is that $1.1 trillion “extra” is sitting out there that shouldn’t have been. Most all of this money ends up in banks, of course. It was never in the form of paper bills, but rather as deposit balance numbers, sitting in the accounts of whoever sold the mortgage-backed bonds to the Fed.

So the banks have that extra $1.1 trillion sitting on their balance sheets. I think in some cases, they in turn parked it with the the U.S. government to get a little bit of safe interest. In many other cases, though, I think they parked it right back at the Federal Reserve.

If the banks turned around and lent that money out new, it would create a huge inflation. It is only money that was “made” because nobody wanted the mortgage bonds. It was not meant to be fresh money that the banks could turn around and make new loans with.

So what has to happen is that the mortgage bonds held by the Fed have to be sold back to the general investing community. And that community will use the cash the Fed created to buy back the mortgage bonds.

This may be done through four or five steps. But at the end of the dance, that is what will be the result. The Fed won’t be holding the $1.1 trillion of mortgage bonds. And the investing public will.

Despite all the talk, most all these bonds are good–especially if the are from Fannie Mae or Freddie Mac, or other federally-backed entities. Congress will pony up any deficiencies. But more so, most everyone in America keeps paying their mortgages. The headlines are about the people who don’t. But most people do.

And they’re paying back with interest. So right now, the Fed gets that interest as profit, which it turns over to the U.S. Treasury. Figuring 5% interest on $1.1 trillion, that’s $55 billion gross right there. Arguably, it’s money that could be used to figure out a way to clean up the bad portion of the American mortgage market, or make whole whoever might get nicked on investing in it.

The financial news, wanting the attention, always dramatizes these things. Even well past the actual drama. What has to go on now is the unwinding of the safety net that the Fed put in place. The Fed could always just dump the bonds out into the public for low bids. (If the bond is worth 100 and they can only sell it to someone willing to pay 80, that would be dumping it. The buyer would pick up the extra 20 (100-80) for nothing.)

I think the Fed is waiting to see what happens when it stops being an active buyer. If the rest of the mortgage market is still doing fine, then the Fed will probably try to put its stash of mortgage bonds out there. If suddenly people aren’t too keen on mortgage bonds, the Fed might step back in as a buyer.

They won’t really know until they do it. So it will be interesting to follow mortgage rates in America during the next couple months.