President Donald Trump recently announced a plan to purchase $200 billion in mortgage bonds, also known as mortgage-backed securities (MBS). Trump intends to use cash reserves from Freddie Mac and Fannie Mae to fund the purchase. But what are MBS, and what does that mean for the economy?
The first question has a definite answer. MBS are investment packages consisting of many home loans. This is not unusual; Freddie Mac and Fannie Mae already package together the individual loans sold to them and resell them to investors as MBS. What is not as common is using cash reserves from Freddie Mac and Fannie Mae to purchase already packaged MBS on the secondary market, as Trump is planning to do. This does not mean it never happens — it’s a standard tactic for intervention during financial crises.
So if it’s a strategy for improving the economy during financial crises, that makes it a good thing, right? Well, not necessarily. What’s most important is the signal being sent. The expectation is that purchasing MBS signals higher demand, which would likely result in increased prices on MBS. With increased prices, MBS yield is lower. With mortgage rates being influenced by MBS yield, this theoretically also reduces mortgage rates for homebuyers. But notice that this involves multiple steps, and not all of them are certain. Supply and demand are often treated like immutable laws, but at their core, they are probabilistic models. And when the model doesn’t conform to reality, there can be disastrous effects, such as the 2008 recession that resulted from purchasing subprime mortgages.
So what we need to know is what sort of signal Trump’s $200 billion MBS purchase is likely to send. According to economists at Realtor.com, probably not much of one. $200 billion may sound like a lot of money, but it’s very little in comparison to the trillions of dollars spent on MBS for financial intervention during the Covid-19 pandemic. While many months of significant MBS purchases certainly had a strong positive impact in 2020-2022, a single low-value purchase doesn’t necessarily signal increasing demand, merely a one-time spike. At most, this could cause a small temporary decrease in mortgage rates. This is especially true because investors are humans, not calculators. They may barely notice the small spike in demand, or they may consider it an uncertain investment, since they’re aware it’s a one-time event. All in all, Trump’s $200 MBS purchase probably won’t have a significant effect on the economy.
Photo by Jakub Żerdzicki on Unsplash
More: https://www.realtor.com/advice/finance/mortgage-bonds-explained-trump-proclamation/