How To Fix The Economy: More Loans, Not Bank Reserves! 2
In our discussion of what role the Fed’s MBS purchases played in the leadup to today’s red hot US housing market, we showed that mortgage lending, not QE, was the crucial driver (and still is).
This is where government intervention can help, by encouraging private sector banks to make more loans.
In the case of housing, this happens because the Fed’s MBS purchases incentivize mortgage lenders to make mortgages (compliant with Government Sponsored Enterprises (GSEs) requirements) and sell them to the GSEs.
The GSEs then securitize them into MBS and issue those MBS to the market, where holders can sell them to the Fed (through the primary dealers). At the end of the day, the Fed stimulates mortgage supply, albeit in a roundabout way, and have quite possibly turbocharged US house prices.
Unfortunately, the other portion of QE, that is the purchases of USTs, does not, and has not stimulated loan demand.
We have seen this with commercial and industrial loans for businesses, and the same general environment of risk aversion is mirrored in banks’ loan activity with consumers.
Looking at the chart, you can see that the amount of consumer loans has yet to recover to its pre-Covid level.
However, unlike commercial and industrial loan volume, which is still falling, consumer loans have at least moved off their pandemic lows, with growth rates turning positive at the end of April ‘21.
Unlike with MBS purchases, banks cannot directly or indirectly sell their business and consumer loans to the Fed.
Firstly, the Fed does not, and probably will not directly purchase loans from banks. If, and this is a very big if, the Fed ever does decide to purchase business and consumer loans from banks, it will likely choose to purchase them in a securitized form, for example Credit Loan Obligations (CLOs).
Secondly, there are no quasi government entities like the GSEs who exist to purchase these types of loans in order to securitize them.
The GSEs are a key part of the MBS purchase channel, as they not only give banks an avenue to sell their mortgages, they also provide a quasi-official US Federal Government guarantee on the mortgages they purchase and use in their securitizations.
Consequently, both the Fed and banks need the GSEs.
The Fed, because they perceive quasi-official US government backing as mitigating the risk of holding MBS. And the banks, because the GSEs are a ready buyer of the mortgages they make for as long as the Fed keeps purchasing MBS.
To be continued…
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