Dick Lepre is senior loan adviser for RPM Mortgage of Alamo,
California, a division of LendUS. He has been in the mortgage
business since 1992 and has been writing a weekly e-mail
newsletter on macroeconomics, mortgages and housing since
1995. Lepre (NMLS #302379) has lived in the San Francisco
Bay Area since 1968. He has a degree in physics from Notre
Dame. Follow him on Twitter @dicklepre. Reach him at (415)
244-9383 or firstname.lastname@example.org.
Get to Know How the Fed Affects Rates
Mortgage professionals should understand what the central bank’s policies
can and can’t accomplish
By Dick Lepre
Many people believe that the actions of the Federal Reserve have substantial impact on mortgage interest rates. This is not the case.
The Federal Reserve is the central bank of the United
States. It acts as a reserve bank and requires member
banks to keep about 10 percent of their customers’
checking and savings deposits at the Fed.
At best, the Fed’s impact on mortgage rates is indirect, inconsistent and relatively small. And that can be
seen by the Fed’s policies and its effect on rates and
the economy since the Great Recession. Mortgage
originators, whose livelihoods depend a great deal on
interest rates, should have a basic understanding of
the Fed and its powers.
Largest piggy bank
The Fed is essentially the world’s largest piggy bank. It
controls the money supply, affects short-term interest
rates and helps regulate commercial banks.
The motivation for the creation of the Fed was to
prevent bank panics. These are prone to occur when
banks experience big losses, and depositors fear that
their accounts are in danger — causing a significant
number of people to withdraw the funds in their
Banks have an underlying problem that many people often don’t recognize. Their liabilities (depositors’
checking and savings accounts) are entirely liquid,
while their assets are largely illiquid. If depositors
show up at teller windows demanding their money,
the bank cannot call you and demand that you pay off
your mortgage loan, for example.
Banks need to meet specific reserve requirements
at the end of each day. If a bank is cash short, either
because people withdrew funds or because businesses with large credit lines tapped them considerably, that bank may need to borrow cash overnight
so that it has sufficient reserves. This is almost always
done by interbank lending (borrowing from another
bank which has excess reserves) with the Fed acting
as the lender of last resort.
In addition to providing stability to banking, the
objective of the Fed is defined by Congress as framing monetary policy to maximize employment, stabilize prices and moderate long-term interest rates.
The Fed runs the government’s monetary policy
while Congress and the president run fiscal policy
(taxes and spending.)
The Fed has significant objectives and powers,
which it wields on a day-to-day basis. These powers
relate to two things: controlling money supply and
controlling short-term interest rates.
The ability of the Fed to control money supply is, in a
sense, magical. It can create money out of thin air. If
the Fed wants to add to the money supply, it makes an
announcement to the large investment banks that it
wishes to purchase Treasury debt.
After the details are worked out, the Fed buys the
Treasury debt from those banks by crediting their
account at the Fed with money which did not previously exist. The Fed has the Treasury debt and the
banks have newly created cash to lend.
This was what the various rounds of quantitative
easing (QE) were about. A way to see QE in action was
to pay attention to excess bank reserves. This is money
banks own that is parked at the Fed and exceeds
the necessary reserves. This money can be instantly
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