Mortgage industry holds it breath

NEW YORK -- The government's $1.25 trillion program to prop up the housing market by purchasing mortgages came to an end last week in a small, messy room at the Federal Reserve Bank of New York with four desks and a Nerf basketball hoop.

For the last year, a small team of traders has worked here to buy massive amounts of mortgages to fill the void left after institutional investors beat a hasty retreat in the throes of the 2008 financial crisis, fearful that the loans would follow countless others into default.

The purchases have given the Federal Reserve its largest balance sheet ever and triggered fears of runaway inflation. But most analysts now credit it for lowering mortgage rates, providing a vital lifeline for the battered housing market.

“Something like this had never been tried on this scale before,” said Mark Gertler, a former resident scholar at the New York Fed and an economics professor at New York University. “The fact that they got it mostly right is quite remarkable.”

Now, with home prices stabilizing and an economic recovery beginning to take hold, the hope is that private investors will fill the gap left by the Fed, ensuring that money will continue to be available to underwrite home loans. Turning mortgages into salable bonds provides lenders with fresh cash that can be used to make new loans.

The team at the New York Fed has been tapering off its purchases in the last few months as other financial institutions began to step in and pick up some of the slack. Mortgage rates have not moved dramatically, and industry experts estimate that they are unlikely to do so in the near future.

“The average guy looking for a mortgage is not going to see much difference,” said Scott Simon, a managing director at bond giant Pacific Investment Management Co. in Newport Beach, Calif.

Before the Fed program began, Pimco and other major traders such as BlackRock Inc. were major buyers of so-called mortgage-backed securities, which are bonds backed by bundles of home loans.

Pimco and other bond traders will step back into the market, Simon said, but they'll demand slightly better investment earnings than the Fed settled for. That, in turn, will push up interest rates for borrowers but only a little, perhaps an eighth of a percentage point, he said.

The program's end removes one of many supports that the government has been providing to the housing market. Others include the federal takeovers of mortgage financing giants Freddie Mac and Fannie Mae and incentives for banks and loan investors to modify mortgages, thus lowering borrowers' payments and curtailing foreclosures.

The team of traders at the New York Fed began buying up mortgage-backed securities about a year ago. Setting up shop on the ninth floor of the New York Fed's imposing stone headquarters near Wall Street, the team eventually grew to about 30 people.

Initially the team directed groups of traders at other investment houses such as Pimco and Goldman Sachs who actually purchased the mortgage-backed securities on behalf of the government.

The back office staff then helped move these bonds to JPMorgan Chase & Co., which serves as a holding bank for the Fed. Early this year, the actual trading shifted to four Fed employees working out of a small ninth-floor office cluttered with old newspapers, empty water bottles and Broadway playbills.

Each day, the traders put out requests to each of the 18 big banks that work with the Federal Reserve, stating what types of mortgage bonds they are looking to buy and in what price range.

As responses came in, the traders determined which prices were good enough if any and then executed the trades on TradeWeb, a computer network used by other banks.

“We acted very much like a regular market participant,” said Andrew Huszar, 37, who has run the mortgage purchasing program.

The end of the program still leaves many uncertainties. The purchases have made the Federal Reserve into the largest single holder of mortgages anywhere, a problem for the federal balance sheet if any of those mortgages go sour.

It also has ballooned the Federal Reserve's balance sheet from $700 billion before the crisis to $2.3 trillion today.

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