Possible cancelling effects in the Fed's MBS policy

A couple of years ago, there was some talk of the Fed unloading its MBS portfolio, which it had purchased with a substantial amount of cash. With QE3, the Fed decided to keep buying more MBSs, driving expected MBS yields down in its efforts to pump money into the housing market. However, as the Fed drives down MBS yields, there is a possibility that potential new entrants to the MBS market will chose other securities over MBSs. In other words, there is a self-defeating element in the Fed's MBS policy also. Whether this effect will prove to be stronger or weaker than the original impetus provided by the Fed through its MBS purchases remains to be decided, especially when the possibility exists of herd mentality playing a role in the housing market.

Other than this possible cancelling effect, efforts by the Fed to change the dynamics of the housing market will face difficulties due also to fundamental market considerations like demand, supply, prices, risk perceptions etc. The fact that the Fed's intervention has not led to any dramatic recovery in the housing market is a confirmation of this fact. Unless there is a large impact on the amount of housing loans, mortgage rates and house prices that can be traced easily to Fed action, as opposed to other factors or natural recovery in the housing market, one should be wary about ascribing any and every change in housing market parameters to Fed action. This is one aspect of the uncertainty that economics is prone to as a subject. And a lot of economic commentary is also prone to carelessness when it comes to ascribing economic dynamics to specific causes. The Fed needs to weigh the pros and cons of its MBS policy initiatives very carefully.

by C. Jayant Praharaj ( send comments to cjpraharaj.blog@gmail.com )