What Is Quantitative Tightening?

What Is Quantitative Tightening? | SmartAsset.com

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In the past two years, investors have taken an unusual interest in the Federal Reserve Bank. That’s mostly due to a Fed policy known as ‘quantitative tightening’, or QT. Effectively, QT was the Fed’s attempt to reduce its holdings after it bought huge amounts of debt during the 2008 Great Recession. While some details will interest only economists, QT  may have implications for financial markets and regular investors. It’s useful to explore the backstory, but a financial advisor can be helpful if you’re concerned about how Fed activity can impact your investments,.

What is Quantitative Tightening?

To understand quantitative tightening, it’s helpful to define another term, which is quantitative easing. To do that, we need to go back to the bad days of 2008.

When the Great Recession hit, the Fed slashed interest rates to stimulate the economy. But it was evident that wasn’t nearly enough to stave off crisis. So the Fed provided another jolt of stimulus by buying Treasury bonds, mortgage-backed securities and other assets in huge volume. This combination of slashing interests rates massive government spending was qualitative easing, or QE, and fortunately it worked. Banks had more cash and could continue to lend, and more lending led to more spending. Slowly, the economy recovered.

But in the meantime, QE exploded the Fed’s balance sheet, which is a tally of the bank’s liabilities and assets. Prior to the crisis, the balance sheet totaled about $925 billion. With all the purchased debt, which the Fed categorized as assets, the balance sheet ballooned to $4.5 trillion by 2017. Years past the financial crisis and with a strong economy, the Fed decided to shrink its balance sheet by shedding some of its accumulated assets, effectively reversing QE.

That reversal is quantitative tightening. QE had poured money into the economy, and through quantitative tightening, the Fed planned to take some of that money out again. First it raised interest rates, which it had plummeted to zero during the financial crisis. Then, it began retiring some of the debt it held by paying off maturing bonds. Instead of  replacing these bonds with new debt purchases, the Fed stood pat and let its stockpile shrink. This effectively reduced the quantity of money under bank control, thus quantitative tightening.

Did Qualitative Tightening Officially End?

There was no official beginning or end to quantitative tightening. The Fed began to ‘normalize’ its balance sheet by raising interest rates in December 2015, the first hike in nearly a decade. In October 2017, it began to reduce its hoard of bonds by as much as $50 billion per month. But after four 2018 interest rate cuts and some stock market downturns, many observers worried the Fed aggressive normalization was too much of a shock to the economy.

In response, the Fed ended the interest rate hikes and slowed down on debt retirement. By March 2019, the cap on reductions reduced from $30 billion a month to $15 billion. By October 2019, the Fed announced it would once again start expanding its balance sheet by buying up to $60 billion in Treasury bills a month.

However, the Fed insisted this was not another round of quantitative easing. Some market observers reacted to that announcement with skepticism. But whether this was or wasn’t a new round of QE, the Fed’s action effectively stopped quantitative tightening.

How Quantitative Tightening Impacts Markets

Many investors worry that quantitative tightening would negatively impact markets. During the past decade, returns have shown a relatively high correlation with the Fed’s purchases. Conversely, the Fed’s selloff of assets was a contributing factor to the market dip in late 2018, which left the S&P 500 about 20% below its top price.

Quantitative tightening definitely made some investors nervous. That said, there are a few things to consider if the Fed shrinks the balance sheet in the future. First, it’s unlikely the balance sheet will contract to its pre-2008 level. The Fed hasn’t indicated where a ‘happy medium’ might be, but the balance sheet remained well about the pre-2008 figures when expansion began again in October 2019.

Additionally, it’s unlikely that quantitative tightening will reverse quantitative easing’s impact on long-term interest rates. In part, the Fed purchased long-term bonds and mortgage-backed securities to move money into other areas, like corporate bonds, and lower borrowing costs. Also, the Fed hoped this activity would encourage the productive use of capital. According to the Fed’s research, the use of quantitative easing reduced yields on 10-year treasury bonds by 50, to 100 basis points (bps).

While quantitative tightening may have reversed some of this impact, experts believe it will not undo long-term interest rates by 100 bps. Ultimately, it comes down to the comparative impact of the expansion and contraction of the balance sheet. In October 2019, the contraction was not nearly sufficient to reverse the expansion.

Other Considerations of Quantitative Tightening

Many investors worry that quantitative tightening will have a big impact on inflation and liquidity. This is because changes in inflation and liquidity may occur when there is a discrepancy concerning supply and demand. During the financial crisis, the Fed increased the money supply since the economic system desperately needed liquidity. A decade and strong recovery later, there’s less liquidly preference. In response, the Fed has decreased  cash reserves. In a strong market, this should have no real impact on liquidity and inflation.

The Takeaway

Quantitative tightening is a monetary policy that increased interest rates and reduced the money supply in circulation by retiring some of the Fed’s debt holdings. After qualitative easing expanded the money supply for several years to bring the economy back on track, the Fed used qualitative tightening as a means to normalize its balance sheet.

While quantitative tightening did not completely reverse quantitative easing, it did shrink the Fed’s balance sheet. This strategy left many investors uneasy about future returns and interest rates. That said, balance sheet normalization did not prove to be as disruptive as many investors feared.

Tips for Investors

  • The Fed’s monetary policy quickly becomes complex, but it’s still useful for investors to keep an eye on the bank’s actions. Since interest rate changes can have direct impact on major purchases and investment plans, understanding the Fed’s reasoning for these decisions can be helpful.
  • Financial advisors can help their clients cut through the noise and translate technical analysis of market observers into plain language. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.

Photo credit: ©iStock.com/drnadig, ©iStock.com/claffra, ©iStock.com/Duncan_Andison

Ashley Chorpenning Ashley Chorpenning is an experienced financial writer currently serving as an investment and insurance expert at SmartAsset. In addition to being a contributing writer at SmartAsset, she writes for solo entrepreneurs as well as for Fortune 500 companies. Ashley is a finance graduate of the University of Cincinnati. When she isn’t helping people understand their finances, you may find Ashley cage diving with great whites or on safari in South Africa.
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Refinance soon to avoid the FHFA adverse market refinance fee

FHFA fee starts on December 1, but rates will go up before that

Starting on December 1, a new “Adverse Market Refinance Fee” will be imposed on most conventional refinances.

But homeowners won’t pay the new fee at closing.

Instead, lenders will cover it by raising refinance rates — likely by as much as 0.125% to 0.25% on average.

To avoid higher rates, you’ll want to refinance before the fee takes effect.

But there’s a catch: to avoid FHFA’s fee, your refinance loan needs to be closed and delivered to Fannie Mae or Freddie Mac before December 1.

Homeowners who want the lowest-possible refinance rate should apply 2-3 months before December 1 — which is pretty much right now.

Find and a low refinance rate now (Feb 9th, 2021)

What is the Adverse Market Refinance Fee?

On August 12, Fannie Mae and Freddie Mac announced they would assess a new fee on all conventional refinance loans.

The fee is equal to 0.5% of the loan amount.

That means if you had a $200,000 refinance, the new fee would amount to an additional cost of $1,000.

Refinances take a long time to close and deliver, so a September 1 start date meant the fee was already being added to refinances in process.

Originally, the fee was meant to start on September first — meaning it would have applied to all loans not yet delivered to Fannie or Freddie by that date.

But because refinances take a long time to close and deliver, the fee effectively started being added to loans that were already in process prior to September 1.

However, Fannie and Freddie have since changed the rules (and delayed the start date for the fee) in response to a strong industry backlash against it.

Changes to the FHFA refinance fee

On August 25th, FHFA announced two changes to the new refinance fee.

  • The start date moved from September 1 to December 1
  • The new charge will not apply to loan amounts below $125,000, or to HomeReady and Home Possible loans

This is good news for borrowers. It means rates may stay a little lower, a little longer.

It also means that borrowers who were already in the process of refinancing might not see their rates go up as a result of the fee.

In fact, loans currently in the pipeline might have their loan costs re-adjusted in borrowers’ favor, notes Matthew Graham of Mortgage News Daily.

But each lender will handle its own loans differently, so make sure you talk to your mortgage company if you were in the process of refinancing.

Also, note that loans must be delivered to Fannie or Freddie before December 1 to avoid the fee.

That means the refinance will have to close much earlier (in October or early November), so time your refinance accordingly.

Find and lock a low refinance rate (Feb 9th, 2021)

The new fee could push refinance rates up by 0.125% or more

When the new fee does go into effect, borrowers won’t pay it directly.

Instead, it’s likely to be charged to borrowers in the form of higher rates.

“The fee is 50bps [0.50%] in terms of PRICE, and that equates to roughly 0.125% in terms of interest rate,” says Graham.

Though others have estimated that refinance rates could rise as much as 0.375% on average when the fee goes into effect.

Either way, that’s a significant difference in refinance rates for borrowers.

For those who planned to refinance in the near future, it makes sense to get the ball rolling as soon as possible.

The earlier you start your refinance, the better your odds of closing and having the loan delivered to Fannie Mae or Freddie Mac before the fee once again goes into effect.

Find a low refinance rate today (Feb 9th, 2021)

Will all refinances be affected by the new fee?

The Adverse Market Refinance Fee will only apply to refinance loans sold to Fannie Mae and Freddie Mac.

In other words, it applies to ‘conventional’ refinance loans.

But other types of mortgages could be affected indirectly.

In fact, the initial announcement set off higher rates for both purchase and refinancing loans, including some not intended for sale to Fannie Mae and Freddie Mac.

Those who had not locked in rates suddenly faced higher interest costs.

So in the coming months, it seems safe to assume that conventional refinances won’t be the only type affected by rising rates.

No refinance fee on loans under $125,000

One piece of good news from Fannie and Freddie’s most recent announcement is that the refinance fee won’t be charged on loans under $125,000.

Note, that’s based on the loan balance — not the home’s value.

So if your home is worth significantly more than $125,000, but you’ve paid down a lot of the balance, you might end up refinancing less than $125K and the fee won’t affect you.

In addition, the fee won’t be charged to those refinancing a Freddie Mac Home Possible loan or Fannie Mae HomeReady loan.

Why was a new fee developed?

We have faced the COVID-19 economy for months. Some 55 million people have filed for unemployment, and lenders have had to adjust many of their policies to account for the added uncertainty.

But did something new happen to justify this extra fee?

According to Freddie Mac, the new fee was necessary “as a result of risk management and loss forecasting precipitated by COVID-19 related economic and market uncertainty.”

Fannie Mae explained that it was adding the fee “in light of market and economic uncertainty resulting in higher risk and costs.”

But on August 25th, a different answer emerged.

According to the Federal Housing Finance Agency (FHFA) — the regulator that runs Fannie Mae and Freddie Mac — the new money was “necessary to cover projected COVID-19 losses of at least $6 billion at the Enterprises.”

“Specifically,” says FHFA, “the actions taken by the Enterprises during the pandemic to protect renters and borrowers are conservatively projected to cost the Enterprises at least $6 billion and could be higher depending on the path of the economic recovery.”

This refers to relief packages passed during COVID-19, which allowed borrowers to skip mortgage payments without penalty and prevented lenders from foreclosing on any delinquent loans.

But this amount is a fraction of the $109.5 billion in profits Fannie and Freddie have added to government coffers, even after paying back bailout funds they received during the 2008 housing crisis, according to ProPublica.

Using a small percentage of past years’ profits to help homeowners through a worldwide pandemic seems like a good idea to us, anyway.

Will Congress stop the new fee before it goes into effect?

The Adverse Market Refinance fee is now set to start after the November election.

So, could the results of the election impact whether or not the fee actually goes into effect?

That’s not certain. Both Congresswoman Maxine Waters (D-CA), Chairwoman of the House Committee on Financial Services, and Congressman Wm. Lacy Clay (D-MO), Chair of the Subcommittee on Housing, Community Development and Insurance, oppose the new charge.

If opposition to the fee is strong enough, there could potentially be an investigation into the fee and an attempt to stop it. But there’s no guarantee this will happen.

What to do if you want to refinance

Rates are still sitting near record lows — below 3% in many cases. This is basically unheard of in the mortgage world.

Rates are likely to go up as the new refinance fee start date nears. But that’s just one of the many, many factors that can impact mortgage and refinance rates.

If the economy starts to see a real recovery any time soon, rates could start going up regardless of what happens with the refinance fee. On the flip side, they’re not likely to go much lower than they are now.

So for borrowers hoping to refinance at record-low rates, it makes sense to get started sooner rather than later.

Verify your new rate (Feb 9th, 2021)

Source: themortgagereports.com

Housing, civil rights groups ask Congress for $25B

A large partnership of housing and civil rights organizations reached out on Monday to congressional leaders advocating for further relief for homeowners in the next COVID-19 stimulus package.  

The letter was signed by representatives of more than 350 housing and civil rights organizations, including American Bankers Association, Mortgage Bankers Association, National Association of Realtors, National Association of Home Builders and the Housing Policy Council, the NAACP, National Urban League, National Fair Housing Alliance and National Consumer Law Center.

The letter calls for $25 billion in direct assistance to homeowners facing hardships as a result of the COVID-19 pandemic, at least $100 million for housing counseling, and just under $40 million for the Fair Housing Initiatives Program.

Of the approximately 3.8 million homeowners past due on their mortgages, over half of them are persons of color, according to Census Bureau.

Recent homebuyers that relied on low- or no-down payment loans from FHA, VA or the Rural Housing Service are at particular risk, the group contends, noting that even six months of forbearance can put borrowers underwater on their mortgages, owing more than their home is worth.


Honest Conversations — a podcast on minority homeownership

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“Moreover, these borrowers are predominantly Black and Latinx families, first-time buyers and low to moderate-income families,” the letter says. “Mortgage payments assistance will be critically important to the nearly 3 million borrowers that remain in long-term forbearance plans from their mortgage servicers. We cannot begin to tackle the racial homeownership and wealth gaps if we do not take steps to prevent a wave of COVID-induced foreclosures and loss of home equity.”

The group is hoping the bulk of the requested $25 billion comes through the recently reintroduced Homeowner Assistance Fund, which can be used by state housing finance agencies. In the letter to Congress, the group states that the HAF can help homeowners by providing direct assistance with mortgage payments and get into affordable loan modifications, while assisting with utility payments, property tax and insurance payments, homeowner association dues and other support to prevent the loss of home equity.

The outreach from housing and civil rights groups comes at a pivotal time for the American housing industry. Recently appointed Treasury Secretary Janet Yellen has said she will play a key role in pushing the Biden administration’s economic agenda on Capitol Hill – which includes aggressive aid distribution in order to avoid an even longer recession.

President Joe Biden has repeatedly said his administration is focused on providing aid for those in need of affordable housing, and his $1.9 trillion American Rescue Plan was recently voted into the budget reconciliation process in order to speed up passage. The plan calls for an additional $30 billion in funding for emergency rental, energy and water assistance for hard-hit households, plus $5 billion in emergency assistance to people experiencing or at risk of homelessness.

All of this at a time in the country where Black homeownership has declined year-over-year, according to a recent Census Bureau report, and the percentage of Americans experiencing housing insecurity has risen to 9.5% – up from 7.2% in late 2020.

“A critical lesson of the Great Recession is that the communities most impacted need targeted, early intervention,” the group wrote in the letter. “Acting now to include these key provisions in the pending COVID-19 relief package will help stem what could be a damaging housing crisis in the U.S. concentrated in low income communities and communities of color.”

Source: housingwire.com