Why is the hot housing market so hot?

J.P. Szafranski, BridgeTower Media Newswires

Farce (noun): a comic dramatic work using buffoonery and horseplay and typically including crude characterization and ludicrously improbable situations. (per Oxford Languages via Google)

“Mortgage-backed security purchases really work a lot like Treasury purchases. They are not especially important in what is happening with housing prices.” – Federal Reserve Chair Jerome Powell, July 2021

I couldn’t agree more with the first sentence, while the assertion in his second sentence is laugh-out-loud funny. What, dear reader, would you suggest is the most important hurdle for the average American seeking to purchase a home? I humbly suggest it might be access to a mortgage loan with affordable monthly payments.

The average home-seeking American goes to a bank or mortgage broker to apply for mortgage financing. Banks make a loan to a qualified borrower to fund the closing of a home purchase. In most cases, after closing, the bank sells the mortgage loan to a government agency like Fannie Mae or Freddie Mac. The government agency then packages hundreds of individual loans into a mortgage-backed security and sells that to investors in the bond market, with a (government-implied ... which is a discussion for another day) guarantee for all principal and interest payments due from borrowers.

Fannie Mae and Freddie Mac determine the price to pay banks for newly originated loans based on what they can receive when they sell new mortgage-backed securities in the bond market. Banks observe this and price mortgage rates accordingly. Given all this, the mortgage loan interest rate for an average American is driven by the bond market.

The most important benchmark in the bond market is the interest rate on the 10-Year U.S. Treasury Note. Bonds of all sorts, including mortgage-backed securities, are priced by traders based on a spread relative to the U.S. Treasury yields. Therefore, if Treasury yields decline in the market, mortgage rates are primed to decrease as well. According to Bloomberg, the Fed has purchased a net $2.6 trillion of new U.S. Treasurys since mid-March 2020. Treasury.gov shows that to be over half of the total new debt issued by the Treasury in that time frame. Do you think that having one buyer in the market soaking up half the supply just might raise prices (and lower yields)?

The Federal Reserve has also purchased a net $1.055 trillion of mortgage-backed securities from mid-March 2020 through July 21, 2021 according to Bloomberg data. The latest data available from SIFMA.org shows that the total value of all agency mortgage-backed securities outstanding increased by just $900 billion from the first quarter of 2020 through the first quarter of this year. The Fed is essentially buying up the entirety of newly available supply in the mortgage market. If the Fed wasn’t spraying newly printed dollars into the mortgage market, do you think interest rates might be higher?

The lower the interest rate paid by the average American mortgage borrower, the higher the price they are willing to pay. Indeed, prices are up 16.61% year-over-year through May per the S&P CoreLogic Case-Shiller U.S. National Home Price Index, an increase that Chair Powell describes as “too much.”

Certainly, we are living through a time of great dislocation and upheaval, which undoubtedly contributes to housing price increases, along with unprecedented fiscal stimulus from the federal government. But to suggest that the Fed’s asset purchases are unimportant to housing prices is truly a farcical assertion.


J.P. Szafranski is CEO of Meliora Capital in Tulsa (www.melcapital.com).