The Role Of The Fed In Affecting The U.S. Housing And Financial Markets
Location
CBM 149
Department
Economics
Abstract
After the 2009 financial crisis, the Fed came up with programs intended to repair the commercial paper market, rejuvenate securitization, and push down interest rates on mortgages. The programs, according to Ball, seem to be working 1 . In the essay, Chicago Fed Letter, the author, Agarwal disclosed that Fed’s recovery program, Term Asset-Backed Securities Loan Facility (TALF) introduced on November 25, 2008 resulted in “greater liquidity in the ABS markets and improved capital funding options for firms” 2 . Christensen analyzes in his article “When Will the Fed End Its Zero Rate Policy?” how investors reacted in December 2013 due to expectations of Fed’s announcement to “exit its zero interest rate policy.” His paper compares the magnitude of Treasury yield due to expectations of FOMC’s reaction in contrast to rather minimal change or better put, stability in FOMC’s projections 3 . Some of the ways the Fed affect mortgage rates are firstly, the banks’ prime rates that they use for interbank lending are based on Fed’s interest rate. According to Kagan, “Banks use the prime rate for interbank lending and may also offer prime rates to their highest credit quality borrowers. Secondly, there seem to be a direct correlation between 10-year Treasury bond yield and mortgage rates, which makes it a good indicator for mortgage rates. According to Kagan, an increase in bond yield spurs increase in mortgage rates, and vice versa. 4 . Since the prime rates are a major indicator for mortgage rates this makes Fed’s decisions on interest rates a vital influence in the housing market. In fact, a recent data analysis reveals that “federal funds rate indirectly influences longer- term interest rates such as mortgages, loans, and savings, all of which are very important to consumer wealth and confidence. 5 A twenty year data from Yahoo Finance reveal that both the Nasdaq and S&P500 were on the increase from 1998 through 2000. They both experienced a sharp decline in 2001. Since then, there had been a gradual increase in both the Nasdaq and S&P500 till the 2008 Great Recession where the both dropped rapidly. Since 2009 there has been a rapid increase, even though they seem to decline this year. A twenty year data from fred.stlouis reveal similar pattern for housing price indexes and Treasury bonds. Data from 1998 through 2018 reveal that Treasury bonds, and Case-shiller index both experienced a sharp decline in 2001, then gradually decreased till the 2008 Great Recession where the both dropped rapidly. Since 2009 there has been a rapid increase until early 2019. This paper seeks to observe trends in these two sectors of the U.S. economy, namely: housing and financial markets, and analyzes the role that Fed plays in affecting securitization of these markets. Using 20-year period time series data we analyze asset-backed securities (ABS) with regards to financial assets – particularly Treasury bonds - in correlation with mortgage- backed securities (MBS) as they drive the fluctuations in mortgage rates.
The Role Of The Fed In Affecting The U.S. Housing And Financial Markets
CBM 149
After the 2009 financial crisis, the Fed came up with programs intended to repair the commercial paper market, rejuvenate securitization, and push down interest rates on mortgages. The programs, according to Ball, seem to be working 1 . In the essay, Chicago Fed Letter, the author, Agarwal disclosed that Fed’s recovery program, Term Asset-Backed Securities Loan Facility (TALF) introduced on November 25, 2008 resulted in “greater liquidity in the ABS markets and improved capital funding options for firms” 2 . Christensen analyzes in his article “When Will the Fed End Its Zero Rate Policy?” how investors reacted in December 2013 due to expectations of Fed’s announcement to “exit its zero interest rate policy.” His paper compares the magnitude of Treasury yield due to expectations of FOMC’s reaction in contrast to rather minimal change or better put, stability in FOMC’s projections 3 . Some of the ways the Fed affect mortgage rates are firstly, the banks’ prime rates that they use for interbank lending are based on Fed’s interest rate. According to Kagan, “Banks use the prime rate for interbank lending and may also offer prime rates to their highest credit quality borrowers. Secondly, there seem to be a direct correlation between 10-year Treasury bond yield and mortgage rates, which makes it a good indicator for mortgage rates. According to Kagan, an increase in bond yield spurs increase in mortgage rates, and vice versa. 4 . Since the prime rates are a major indicator for mortgage rates this makes Fed’s decisions on interest rates a vital influence in the housing market. In fact, a recent data analysis reveals that “federal funds rate indirectly influences longer- term interest rates such as mortgages, loans, and savings, all of which are very important to consumer wealth and confidence. 5 A twenty year data from Yahoo Finance reveal that both the Nasdaq and S&P500 were on the increase from 1998 through 2000. They both experienced a sharp decline in 2001. Since then, there had been a gradual increase in both the Nasdaq and S&P500 till the 2008 Great Recession where the both dropped rapidly. Since 2009 there has been a rapid increase, even though they seem to decline this year. A twenty year data from fred.stlouis reveal similar pattern for housing price indexes and Treasury bonds. Data from 1998 through 2018 reveal that Treasury bonds, and Case-shiller index both experienced a sharp decline in 2001, then gradually decreased till the 2008 Great Recession where the both dropped rapidly. Since 2009 there has been a rapid increase until early 2019. This paper seeks to observe trends in these two sectors of the U.S. economy, namely: housing and financial markets, and analyzes the role that Fed plays in affecting securitization of these markets. Using 20-year period time series data we analyze asset-backed securities (ABS) with regards to financial assets – particularly Treasury bonds - in correlation with mortgage- backed securities (MBS) as they drive the fluctuations in mortgage rates.
Comments
Hardik Marfatia is the faculty sponsor of this project.