Agency MBS Purchase: Definition, Mechanism, and Economic Impact

Agency MBS purchase involves the deliberate acquisition of mortgage-backed securities (MBS) issued by government-sponsored enterprises (GSEs) such as Fannie Mae, Freddie Mac, and Ginnie Mae. This practice, often associated with the U.S. Federal Reserve, began on Jan. 5, 2009, as a strategic response to the 2007–2008 financial crisis. It aimed to mitigate the impacts of the crisis by stabilizing the housing market and fostering liquidity in the financial system. This initiative was subsequently reinstated on March 15, 2020, during the COVID-19 crisis, highlighting its significance in times of economic turbulence.

Financial institutions commonly engage in selling a significant portion of their active mortgages to participants in the secondary mortgage market. This market includes institutional investors, private firms, and governmental entities. The mortgages are then bundled into pools, a process known as securitization, creating mortgage-backed securities (MBS). These securities, functioning similar to bonds, are subsequently sold in the open market to investors.

Agency MBS, a specific category within the MBS market, is issued by government agencies such as Ginnie Mae, Fannie Mae, and Freddie Mac. The New York Fed’s Open Market Trading Desk, authorized by the Federal Open Market Committee (FOMC), conducts agency MBS purchases. These securities are held in the System Open Market Account (SOMA), and principal payments received are reinvested in newly-issued MBS backed by the mentioned government-sponsored entities. This process effectively increases reserve balances in the banking system.

It’s noteworthy that while Fannie Mae and Freddie Mac initially operated as government-backed entities, they were later privatized. Before 2008, their MBS did not meet the Fed’s criteria for eligibility due to the absence of explicit U.S. Treasury backing.

Following the onset of the credit crisis in 2007, the FOMC implemented unconventional monetary policies to stabilize the banking system and ease credit conditions for borrowers. These policies included quantitative easing (QE) and targeted credit facilities. The $1.25 trillion agency MBS purchase program played a crucial role in these efforts, constituting a major component of the Fed’s QE policy.

This initiative was carried out in conjunction with the U.S. Treasury’s Troubled Asset Relief Program (TARP), aiming to bail out banks and holders of MBS that had fallen in value due to mortgage defaults. The Treasury’s conservatorship of GSEs enabled the Fed to purchase their securities, indirectly facilitating the monetization of Treasury spending under TARP and the GSE bailout.

In 2020, responding to the economic turmoil induced by the COVID-19 pandemic, the Fed resurrected financial bailout measures, including QE and agency MBS purchases. On March 23, 2020, the central bank announced its intent to purchase unlimited quantities of Treasury and agency securities to support its QE program, underscoring the ongoing relevance of agency MBS purchases in times of crisis.

The agency MBS purchase program is strategically designed to provide support to mortgage and housing markets and foster improved conditions in financial markets. Initiated in Jan. 2009 amidst a global economic downturn, the program’s overarching goal was to reduce long-term interest rates. The mechanism behind this involves the purchase of a significant amount of bonds in the market, driving up bond prices. As bond prices increase, the interest rates decrease, thereby stimulating economic activity by making borrowing more affordable.

By the time the Fed completed the purchase program in March 2010, the S&P 500 had appreciated significantly, and global equity markets had experienced a positive trend, surpassing the Fed’s optimistic expectations. The program proved instrumental in providing price support and alleviating panic among market participants.

Agency MBS purchases have emerged as a critical tool in the arsenal of central banks, especially during times of financial crises. The historical context, spanning from the Great Recession to the recent challenges posed by the COVID-19 pandemic, showcases the adaptability and relevance of this strategic initiative. As a mechanism to stabilize markets, reduce interest rates, and support government-sponsored entities, agency MBS purchases play a pivotal role in shaping the trajectory of the financial landscape.

Agency MBS purchases have a broad impact by stabilizing mortgage and housing markets, fostering improved conditions in the overall financial landscape. The reduction in long-term interest rates also contributes to stimulating economic activity by making borrowing more cost-effective.

GSEs like Fannie Mae, Freddie Mac, and Ginnie Mae issue the mortgage-backed securities (MBS) that are strategically acquired through agency MBS purchases. The program is a measure to prevent the bankruptcy of these entities by supporting the prices of their securities.

While agency MBS purchases are designed to stabilize markets and reduce interest

rates, there are potential risks. Dependencies on central bank interventions and the possibility of market distortions are factors to consider when evaluating the impact of these purchases.