Bernanke’s Fed Financing $1 TRillion of Toxic Home Mortgages

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Q&A-5 of the First Short Quiz explains that: “Financing long-term fixed-return assets with short-term borrowing (customer deposits) is INSANE because any rise in short-term interest rates makes the long-term low-return assets TOXIC.”

And Q&A-6 explains that the Federal Reserve is acting properly in buying $1 TRillion/year of TOXIC home mortgages: “Because the U.S. Federal Reserve, unlike European central banks, has been tasked in the U.S. Code with the objective of maintaining U.S. employment in addition to minimizing inflation. And no other institution can print money to finance TOXIC assets. Which means that the entire housing sector would continue to be an albatross around the neck of the U.S. economy unless the Fed acted as it did.”

It is easy to read these Q&A’s without really understanding them.

An illustration of the TOXICITY of making home-mortgage loans???

During the past month, the Federal Reserve effectively raised from 3.5% to 4.5% the interest rate homeowners pay on the mortgages the Fed is purchasing (NB: as discussed, since the 2008-201? Economic Meltdown, the Fed is “the only game in town” when it comes to originating new mortgages!!!).

What did this do to the value of an existing 3.5% mortgage loan if the Federal Reserve were to try to sell one of the $1 TRillion worth of home mortgages that it financed during the last year???

A 30-year mortgage loan for $250,000 at 3.5% incurs a monthly payment of $1,122.61 for principal and interest.

A 30-year mortgage loan for $250,000 at 4.5% incurs a monthly payment of $1,266.71 for principal and interest.

Therefore, if it is assumed* that both mortgage loans remain outstanding for the entire 30-year term, the value of the 3.5% mortgage has plummeted 12.8% overnight as a result of the increase in the interest rate from 3.5% to 4.5%. Because, of course, the 3.5% mortgage loan is no longer earning a market rate of interest income.

[* NB: Because homeowners typically sell before owning their homes for 30 years, the calculation of market value of a mortgage loan is adjusted to take the statistical probability of such an event into account.]

No wonder that Q&A-5 calls “INSANE” the practice of the Savings & Loan Associations of the 1980’s and 1990’s of financing long-term home-mortgage loans with short-term borrowing (government-insured customer deposits)!!!

And no wonder that Q&A-5 calls attention to the virtually-universally-overlooked fact that no for-profit institution can afford to engage in such INSANITY!!!

And that only a financial institution THAT CAN PRINT MONEY can engage in such INSANITY!!!

Because, of course, the Federal Reserve can just print more money to cover its losses!!!

And the Federal Reserve does not even have to disclose that it has incurred a loss on the order of $128 Billion (at the 12.8% calculated above) on the $1 TRillion of mortgage loans it made during the last 12 months.

Incurred by virtue of its own action in raising the rate on new 30-year home mortgages during the last month from 3.5% to 4.5%!!!