The Fed decided to go slow on removing housing stimulus--and that's a good thing

09/24/2009 8:54 am EST


Jim Jubak

Founder and Editor,

I heard what I was hoping to hear in yesterday's statement from the Federal Reserve' s Open Market Committee: the U.S. central bank isn't going to cut back its support for the U.S. mortgage market ahead of schedule or abruptly.

And that will keep mortgage interest rates from jumping so much that they kill off any chance of a recovery in the housing sector.

The Federal Reserve has been buying mortgage-backed securities hand over fist during the financial crisis. It has had to since private buyers have pretty much disappeared from the market.

 And without someone buying this paper banks would have quickly run out of mortgage money to lend. (Banks make mortgages and then Wall Street lumps those mortgages into mortgage-backed securities. When those are sold to another buyer, the bank that made the original mortgage gets its money back and can make more mortgages. It's a way to multiply capital and that keeps mortgage money available and relatively cheap.)

The Fed launched a program to buy mortgage-backed securities late last year. Right now the Fed is about 2/3 of the way to the $1.25 trillion target that it set for the effort. The fear was that the bank would stop soon buying soon by redefining that target as "up to" $1.25 trillion rather than buying the full amount.

An abrupt and early end to the buying program could easily raise mortgage rates of 0.5 percentage points or more. And that, along with the anticipated December 1 end of the government's $8,000 tax credit to first-time new home buyers would have had a crushing effect on struggling home builders.

But on September 23, the Fed said it will buy the full $1.25 trillion in mortgage-backed securities and it will stretch out the buying until March rather than ending it with the turn of the year.

The decision wasn't nearly as cut and dried as the announcement made it seem. There's a substantial minority on the Fed that want to get the bank out of the credit markets as quickly as possible. Federal Reserve chairman Ben Bernanke, a student of the Great Depression, has countered by arguing that cutting stimulus too quickly is what plunged the nation back into depression in 1937 and that he'd prefer not to make that mistake again .

For more on the effects of ending stimulus on the housing market see my post .For more on how cutting stimulus efforts too early led to disaster in 1937 see my post .
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