The Fed’s purchase of assets has increased dramatically since the start of the pandemic, representing 31% of GDP compared to just 6% in 2005, keeping rates low.
By Manuel Gutierrez, Consulting Economist to NKBA
The Federal Reserve Bank (Fed) has followed a policy of infusing huge volumes of liquidity into the U.S. economy for more than a decade, and one result has been historically low interest rates — good news for the housing sector.
Initially, that policy was implemented under the guise of avoiding a severe economic recession following the 2007-2009 financial and housing collapse.
After the recession, the Fed started buying mortgage-backed securities (MBS) and U.S. Treasury securities in three separate stages, known as “quantitative easing,” or QE1, QE2 and QE3. In 2009 alone, the Fed purchased $908 billion in mortgage-backed securities and about $300 billion in U.S. Treasury notes. Until 2008, the Fed had around $475 billion in U.S. Treasury notes, and did not have any MBS on its balance sheet.
The Fed continued to purchase both types of assets through the following four years. By 2015, it had over $4.1 trillion worth of these securities on its balance sheet (Fig. 1).
The balance sheet remained relatively stable until last year, when, to support an economy that was suddenly hit by the pandemic, it proceeded to inject more liquidity by purchasing additional U.S. Treasury and mortgage-backed securities. Since last March, the Fed’s balance sheet has increased by $2.2 trillion in its holdings of U.S. Treasury securities, and by $670 billion in mortgage-backed securities. Currently, as shown in Figure 1, the Fed has $4.7 trillion in U.S. government securities and an additional $2.04 trillion of mortgage-backed securities.
To put these figures into perspective, the Fed’s asset holdings were just 6% of GDP in 2005. By the end of last year, it had ballooned to 31% of GDP. Will this increase have a negative impact on the economy in the future? Nobody knows for sure.
One of the results of this influx of liquidity has been the downward pressure on interest rates. Interest rates for all types of loans have been dropping lower and lower over the last decade.
Figure 2 displays the so-called Fed Funds Rate. This is the rate that banks pay to other banks for funds they borrow overnight to meet their reserve requirements.
Legally, a bank has to have a certain amount of reserves, assets such as cash, to back up the liabilities on its balance sheet. When a bank is short the amount required by law, it simply borrows in the overnight market from other bank(s) to make up the difference. But those funds borrowed are not free. Like any loan, they require an interest payment, which, in this case, is called the Fed Funds Rate.
Figure 2 shows that the Fed Funds Rate had been rising since 2017, following the stated policy of the Fed to increase interest rates beginning that year. But the policy was reversed with the advent of the pandemic, bringing the rate to its current level of 0.09% — barely above zero.
Mortgage rates have fallen as a result of the infusion of liquidity and the lowering of the Fed Funds rate. Figure 3 shows that interest rates on 30-year fixed-rate loans have fallen by one percentage point, to 2.65%, since early 2020.
This, of course, is good news for both homeowners with an existing mortgage and for prospective home buyers. The lower mortgage rates enable homeowners to lower their monthly payments if they refinance or if they wish to purchase a new home.
