The Fed reports that it has fully recouped, with interest, the more than $70 billion in loans that it made to support the 2008 sale of Bear Stearns to J.P. Morgan and the bailout of AIG (shown on its balance sheet as “Maiden Lane” investments). This brings to a close a contentious chapter in the central bank’s history. It means that the Fed made a wise decision back in 2008, much wiser than all of the private investors who shunned these securities, right? Well, not exactly.
You see, the Fed bought $12 billion in 10-year Treasury bonds back in April, driving yields below 2%. The vast majority of mortgage rates in the U.S. are based on a spread above 10-year Treasuries (some really big commercial deals are based on the LIBOR). Consequently, rates on 30-year residential mortgages are about 3.7%, leaving mortgage investors with meager returns. Chasing anything that glitters, investors are willing to wade through the mortgage-backed securities swamps that they previously avoided, looking for lost change.
So, by driving down mortgage rates the Fed has managed to create a market for mortgage-backed securities. It’s a cool trick but, like most magic, it’s simple once the secret is revealed.
Doug McKnight has been a commercial real estate appraiser for 23 years. He previously served as a director for the national appraisal firm Marshall & Stevens. He is currently the managing director of CapStruc Advisors and is working on a book on the value of assets.