Compared to 2008, Will the Fed’s Relief Efforts Be Enough to Avert Another Mortgage Crisis?

Different Recessions, Similar Policy Tools

The 2008 and 2020 crises each dramatically reduced economic activity, yet they arose from different causes. The 2008 crisis started, in part, when the housing market crashed after lenders approved mortgages to many buyers who normally would not qualify.[1] The banks holding residential mortgage-backed securities sold these derivatives to secondary investors. Subsequent mortgage defaults led to institutional financial losses that in turn caused lending and investment in other sectors to drop sharply. The current 2020 crisis came from a pandemic that led to state and local governments shutting down many businesses.

Certain similarities are becoming undeniably apparent. For example, in order to meet financial obligations during the pandemic, many businesses may be forced to rely upon issued credit that they may not be able to pay back later due to continued revenue losses. And consumers have seen their buying power deteriorate sharply. In response, we have seen the Fed reach into its 2008 toolkit to mitigate the shutdown’s effects and to provide liquidity to the financial system, including the housing market:

First, the Fed has approached interest rates in 2020 the same way it approached them in 2008, i.e., by reducing them to nearly zero. Doing so decreases mortgage and home loan borrowing costs. Lowered costs lead to more mortgage and home loan borrowing, investments, and home sales, thereby bolstering the housing market. Because interest rates were lower at the start of the 2020 pandemic than in 2008,[2] the recent interest rate reduction may impact the housing market less than the rate slashing of 2008.

Second, the Fed resurrected the 2008 Troubled Asset Relief Program (TARP) to lend to holders of mortgage securities. In 2008, TARP funds were allocated to stabilize many areas, including, among others, programs to assist American families with avoiding foreclosure. TARP was criticized for failing to rescue the housing market and did little to prevent foreclosures. TARP did, however, encourage banks to continue lending within the housing sector and likely prevented a higher unemployment rate, which could have led to even more foreclosures.[3] TARP’s renewed reach has now been expanded to include securities based on commercial mortgages, which is intended to increase lending in the commercial real estate market.[4]

Third, the 2008 Fed purchased Treasury bonds in order to reduce long-term mortgage rates.[5] Because bondholders tend to also hold mortgage-backed securities, any fluctuations in these yields are in turn passed on to consumers in their mortgage rates. Reduced mortgage rates promote housing and commercial real estate transactions. The Fed continued this effort in 2020, but it also began buying mortgage-backed securities and, unlike 12 years ago, has placed no limits on the amount that it may purchase.[6]

Fourth, the Fed reinitiated the Term Asset-Backed Securities Loan Facility (TALF). TALF provides support to smaller businesses and consumers by providing $100 billion in loans to “asset-backed securities collateralized by new loans,” including, among other asset classes, “existing commercial mortgage-backed securities.”[7] This, too, will increase the ability of the issuers of such securities to invest in commercial mortgages, thereby making more credit available to borrowers, developers, and purchasers of commercial mortgage properties.

Another Mortgage Crisis or Short-Term Dip?

COVID-19 has largely halted home sales across the country. Unlike the 2008 recession when home prices plummeted rapidly, home values have faced a nominal price reduction to date. And initial indicators suggest mortgage rates may be reduced. But, as the lockdown continues and job losses mount, we may see businesses and consumers unable to make past-due mortgage and rental payments on commercial and residential properties, leading to increasing levels of defaults and delinquencies.

To counteract these threats to the mortgage market, the Fed will continue its efforts to encourage mortgage lending and assist financially-stressed borrowers by keeping interest rates low. The Fed’s recent purchases of mortgage-backed securities indicate that mortgage rates will remain low in the coming months. At the start of the pandemic, mortgage rates were significantly lower than they were in 2008,[8] and could be pushed lower still. There will likely be an uptick in refinancing activity due to low rates.

But, the overextension of lending, as evidenced by the inability of borrowers to repay their loans on a timely basis, remains a key concern in the housing industry, notwithstanding the Fed’s efforts to lessen the fiscal pressures.

Will TARP, TALF, and the purchase of mortgage-backed securities prevent a second mortgage crisis? These programs are intended to increase liquidity in the housing market, as the Fed buys assets and securities from lenders and investors so that additional loans can be made. The heart of the 2008 mortgage crisis was the consumer’s inability to repay the mortgages at the terms they had been issued due to high-interest rates and risky lending terms. These defaults caused losses to primary and derivative mortgage-backed security holders and halted new transactions.[9] During the 2020 pandemic-fueled economic downturn, the Fed has taken steps to maintain liquidity, which may help to prevent a repeat of the 2008 housing market crash.

Takeaways

The Fed has recently reached into its 2008 toolkit of stimulus efforts. The lowering of interest rates, repurchasing of bonds, and reinstating TARP and TALF are familiar mechanisms for easing the burden on the housing industry, but now they reach further and deeper. The extent to which the housing industry will be affected by the crises may depend on the duration of the current pandemic. At the very least, mortgage refinancing is likely to jump in the short term as buyers take advantage of lowered rates.

[1] See Paul Davidson, Nathan Bomey, & Jessica Menton, It May Feel Like 2008 All Over Again, But Here's How The Coronavirus Crisis Is Different, USA Today (Mar. 11, 2020).

[2] See Liz McCormick, David Goodman, & John Ainger, Chaos of 2020 Can’t Match 2008 But The Gut Punch Feels Familiar, Bloomberg (Mar. 10, 2020); see also Louis Sheiner, How Does The Coronavirus Pandemic Compare To The Great Recession, And What Should Fiscal Policy Do Now?, Brookings Inst. (Mar. 12, 2020.

[3] See Initiative on Global Markets, Bank Bailouts, Univ. of Chicago Booth School of Bus. (Mar. 6, 2012).

[4] See Jeffrey Cheng, Dave Skidmore, & David Wessel, What’s the Fed Doing In Response To The COVID-19 Crisis? What More Could It Do? (April 9, 2020).

[5] See Davidson, supra note 1.

[6] See Jeff Cox, The Fed Is Providing Way More Help For The Markets Now Than It Did During The Financial Crisis, (Mar. 24, 2020); see also Cheng, supra note 4; Federal Reserve Bank of New York, Statement Regarding Treasury Securities and Agency Mortgage-Backed Securities Operations (March 23, 2020).

[7] See Cheng, supra note 4.

[8] Rates were at 3.5% in January 2020 compared to 6% in January 2008. See Freddie Mac, Mortgage Rates Increase Slightly (Apr. 23, 2020).

[9] Kimberly Amadeo, Subprime Mortgage Crisis, Its Timeline and Effect: Follow the Timeline of Events as They Happened, The Balance (Nov. 20, 2019).