This Is Why the Fed Should Stay the Hell Out of the Stock Market

March 30, 2020 6:34 PM UTC
The Federal Reserve should stay the hell away from the stock market. Need proof? Just look at its mortgage bond-buying fiasco.
  • The Mortgage Bankers Association warned that the Federal Reserve’s purchase of mortgage-backed securities has disrupted the market.
  • As a result, lenders may be unable to meet hedge calls from brokers within one or two days.
  • The warning casts an ominous shadow on predictions that the Fed could dive into the stock market next.

The Mortgage Bankers Association has told the Federal Reserve to keep its mitts off mortgage bonds. And if there’s anything this fiasco proves, it’s that the U.S. central bank needs to stay the hell away from the stock market too.

In a somber letter to regulators, the MBA warned that the Federal Reserve has put the U.S. housing market “in danger of large-scale disruption.”

Why? Because the Fed purchased $183 billion in mortgage-backed securities last week. The MBA argues that the move caused an explosion in margin calls on mortgage lenders. Consequently, lenders are at risk of running out of working capital.

At an unprecedented time when the Fed may begin passively purchasing stocks, this warning outlines the significant risks of intervention. Instead of helping an increasingly serious situation, the Fed’s commitment to “infinite” aid may end up making things infinitely worse.

The Federal Reserve Threatens Survival Of Mortgage Lenders

The Fed’s mortgage bond fiasco doesn’t bode well for potential future plans to intervene in the stock market. | Source: Tyler Olson/Shutterstock.com

The Federal Reserve is only trying to help, it would claim. But the MBA has written in no uncertain terms that the Fed’s unprecedented purchase of mortgage-backed securities has endangered lenders.

Prior to the Fed’s intervention, lenders relied on a hedge position. It would pay out in cases where the current market rate is higher than the mortgage rate they originally signed with customers. Hence, it protects them against a rise in the cost of their borrowing.

The MBA alleges that the Fed has effectively ruined this:

The dramatic price volatility in the market for agency mortgage-backed securities over the past week … is leading to broker-dealer margin calls on mortgage lenders’ hedge positions that are unsustainable for many such lenders.

Because of the Fed’s purchases, the market rate has fallen, after being raised in previous weeks by lenders.

As a result, broker-dealers have submitted margin calls to lenders, forcing them to pay out tens of millions of dollars a pop. At the same time, homebuyers haven’t been able to close on mortgages due to lockdowns.

All of this robs lenders of working capital. And according to the MBA, it will only be one or two days before lenders won’t be able to meet margin calls.

Margin calls on mortgage lenders reached staggering and unprecedented levels by the end of the week. For a significant number of lenders … these margin calls are … threatening their ability to continue to operate.

The Fed May Set Fire to the Stock Market Next

If the “coronavirus recession” continues to pummel the stock market, analysts believe the Fed could step in to stop the bleeding. | Source: Yahoo Finance

Yet the MBA’s letter, written to the SEC and Financial Industry Regulatory Authority, doesn’t concern only the mortgage market.

Because when the Fed is gearing up for unlimited spending, it concerns the U.S. and global economy more generally.

“We should allow the central bank to purchase a broader range of securities or assets,” said Boston Fed President Eric Rosengren, earlier in March.

And while buying stocks would require a legislative change to the Fed’s mandate, the bank already announced it would begin purchasing bond ETFs as part of its stimulus efforts.

Source: Twitter

Analysts believe it could secure congressional approval to begin directly buying stocks if the economic situation deteriorates further.

“They’re taking whatever steps they can,” Lindsey Bell, chief investment strategist at Ally Invest, told CNBC. “That would be new territory for the Fed, not that they’re scared of new territory.”

But as its intervention in the mortgage bond market proves, the Fed Reserve’s stock-buying spree could cause as many unintended problems as it solves.

So maybe it would be better to just accept that a lockdown necessarily entails an economic slowdown, and wait until the coronavirus crisis is over before trying to launch the stock market back to all-time highs.

Disclaimer: This article represents the author’s opinion and should not be considered investment or trading advice from CCN.com.

Josiah Wilmoth edited this article for CCN.com. If you see a breach of our Code of Ethics or find a factual, spelling, or grammar error, please contact us.

@_simonchandler_

Markets Contributor for CCN living in London, UK. Has a Bachelor's degree in History and Archaeology from Reading University in 2006, and a Master's in Philosophy from King's College London in 2011. Also contributes to Forbes and Digital Trends, among others. Email me | Follow Me on Twitter | My Website | Muck Rack