PrefBlog

The Federal Reserve has announced:

that it expects to begin operations in early January under the previously announced program to purchase mortgage-backed securities (MBS) and that it has selected private investment managers to act as its agents in implementing the program.

Under the MBS purchase program, the Federal Reserve will purchase MBS backed by Fannie Mae, Freddie Mac, and Ginnie Mae; the program is being established to support the mortgage and housing markets and to foster improved conditions in financial markets more generally.

Of great interest are the published FAQs:

How will purchases under the agency MBS program be financed?
Purchases will be financed through the creation of additional bank reserves.

It is not clear to me just what this means. Will the Fed be getting a deposit from Treasury, financed by sale of Treasuries? Or will they finance it via a bookkeeping entry, aka “printing money”?

One way or another, watching the Fed’s balance sheet has been a lot more interesting than normal lately!

Update, 2008-12-31: Another interesting thing about this is the lack of duration hedging. Players will often hedge the duration hedging of an MBS portfolio by taking market action in Treasuries and entering fixed-receive swaps:

As a consequence of record levels of refinancing in the second half of 2002 and the first half of 2003–which, by our estimates, encompassed roughly 45 percent of the total value of home mortgages outstanding–MBS duration fell to exceptionally low levels. As mortgage and other long-term rates rebounded last summer, a consequence of rapidly improving economic conditions and the fading of deflationary concerns, refinancing fell sharply, removing most downward pressure on duration. Holders of MBS endeavoring to hedge developing interest rate gaps rapidly shed receive-fixed swaps and Treasuries, and these actions markedly aggravated last summer’s long-term interest rate upturn.

There’s a comment on an unsigned blog:

Credit spreads on corporate debt have generally made yet another explosive move higher, as treasury yields have imploded in the recent blow-off move in government notes and bonds. Note in this context that we have once again a case of ‘unintended consequences’ at work here, as the implosion in treasury yields can be attributed directly to the Fed’s decision to [monetize] $800 bn. in MBS and ABS, forcing duration hedging of large MBS portfolios.