paper about MBS

Under this schedule the portfolio will fall below

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Unformatted text preview: Under this schedule, the portfolio will fall below $250 billion in 2021. We believe that the gradual wind-down is a good plan. By putting a cap on the overall size of the portfolio, it allows for some new purchases to the extent that the existing portfolio shrinks fast enough. By announcing an average annual percentage reduction in the portfolio, the private market can form expectations about future conditions in the mortgage market and plan accordingly. However, the swift modification of the agreement in 2009, less than a year after the agreement had been in place, does not bode well for the future. It highlights the potential for future backsliding at the discretion of the politicians in charge. We recommend that a firm plan be included in a GSE reform bill, with strict enforcement, and that the plan be kept in place until the entire portfolio is sold off. The FHFA should be given authority to exercise strict oversight over this wind-down. Finally, we recommend that the reduction of the portfolio should be accelerated beyond the 10% annual reduction whenever market conditions allow. As housing market conditions improve and foreclosures return to normal levels, the prices for mortgage-backed securities (MBS) will stabilize and improve as well. When this happens, the GSE RTC should accelerate its sales to private market participants. While the cost of an accelerated exit may be to affect prices adversely, the benefit is to minimize the risk to the tax payer that stems from declines in the value of the mortgage portfolio when interest rates increase from their historically low levels. 108 The only goal of the GSE RTC would be to wind down the portfolio in a fashion that minimizes the present value of losses to tax payers. The above analysis also suggests a way for the Federal Reserve to act in a likewise manner. As we explained in Chapter 6, the Federal Reserve now owns $1.25 trillion in GSE MBS and $175 billion of Agency debt. As with the retained mortgage portfolio, an accelerated sale of these holdings would prevent future losses due to rising mortgage rates but doing it in an unfavorable environment would further depress MBS prices. To avoid depressing MBS prices too much, a measured pace of divestment seems to be the best course of action. An additional argument for a faster rather than a slower divestment is that monetary policy should not be influenced by the Fed’s holdings of MBS. It is easy to imagine a scenario where interest rates are kept too low for too long in order to avoid losses on the MBS portfolio held by the GSEs or by the Fed itself. Such considerations fly in the face of sound monetary policy, which should focus on overall price stability in the economy. This last consideration makes the Federal Reserve a less-than-ideal candidate to be the lender of last resort in U.S....
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Under this schedule the portfolio will fall below $250...

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