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A surging U.S. housing sector is forcing Federal Reserve officials to consider a policy option many FOMC members would likely prefer to avoid, current and former officials tell MNI -- the possibility of leading a taper of QE with a larger reduction of mortgage bonds than Treasuries.
"I think there'll be an appetite for tapering MBS a bit faster than Treasuries," said Jonathan Wright, a former member of the Fed Board's division of monetary affairs and current New York Fed adviser.
"There are those who are more worried and would particularly want to dial back on MBS and I could actually see that being a consensus of the Committee, that they want to first of all get out to the MBS market."
U.S. home prices jumped 12% in February, matching a record increase in February 2006, just before the housing market cratered and dragged the economy into the Great Recession. Housing starts for April also hit a 15-year high.
"The Fed has to start the tapering process one way or another and MBS is a good category to start with given the strength in housing," said Chan-Guk Huh, a former San Francisco Fed economist.
When the Fed first embarked on QE in response to the Great Recession, it bought mortgage-backed securities because the housing market was the focal point of the crisis. Officials then argued they were trying support the broader economy, not a specific sector, a view Fed Chair Jerome Powell reiterated in his last press conference.
But minutes from the Fed's April meeting showed "a number of participants commented on valuation pressures being somewhat elevated in the housing market."
THIS TIME IT'S DIFFERENT
While there is broad consensus today's housing market is not as susceptible to a crisis thanks to Dodd-Frank and other reforms which have strengthened banks and boosted their capital, there are still signs of froth, and many first-time homebuyers are being priced out of the market.
"Households have plenty of equity, and the credit quality of the stock of mortgage debt is much higher than in 2006 -- there's no subprime to speak of," said Andrew Haughwout, senior vice president at the New York Fed who focuses on the housing sector. But he pointed to growing investor activity in the market. "It's not nearly as high a share as back in 2006. But it's growing and it's something we need to watch."
That kind of shift has already prompted a couple of regional Fed presidents to publicly express openness toward the idea of leading a taper with MBS.
A VOCAL MINORITY
The Fed is currently buying USD120 billion in bonds monthly -- USD80 billion in Treasuries and USD40 billion in MBS -- to support the economy, and has vowed to keep doing so until the country makes "substantial further progress" toward stable price and full employment goals.
"I think this would be a good topic for debate and will be debated once that topic is open but let's let the chair open up that discussion," Bullard told reporters during a Wednesday press briefing in response to a question from MNI, sketching out the broad lines of a disagreement among policymakers over how to treat MBS and Treasuries.
"Some people would say they are very similar because Freddie Mae and Freddie Mac are still in conservatorship so it's like a Treasury bond," he said. "Other people think there's more segmentation in the market and you're feeding into the housing boom by purchasing the MBS."
Eric Rosengren and Robert Kaplan, presidents of the Boston and Dallas Feds respectively, appear to be in the latter camp.
"I do think that as we think about tapering one of the things that we are going to have to think about is at what speed we taper the Treasuries versus the mortgage-backed securities," said Rosengren in a recent Q&A. "One of my financial stability concerns would be if the housing market gets too overheated."
The Fed has historically been reluctant to either acknowledge or try to prick asset bubbles, and remains that way today.