Mortgage markets could come under pressure if the Federal Reserve winds down ongoing purchases of $1.25 trillion in mortgage-backed securities by the end of March as planned, members of the Federal Reserve’s Open Market Committee acknowledge, and some are in favor of expanding and extending the program.

Minutes of the Open Market Committee’s Dec. 15-16 meeting released today show some disagreement over the future of the Fed’s MBS purchases, which are widely credited as helping keep interest rates at record lows in 2009.

Mortgage markets could come under pressure if the Federal Reserve winds down ongoing purchases of $1.25 trillion in mortgage-backed securities by the end of March as planned, members of the Federal Reserve’s Open Market Committee acknowledge, and some are in favor of expanding and extending the program.

Minutes of the Open Market Committee’s Dec. 15-16 meeting released today show some disagreement over the future of the Fed’s MBS purchases, which are widely credited as helping keep interest rates at record lows in 2009.

Although the committee last month publicly affirmed its intention to wind down the Fed’s MBS purchases by the end of March, it also promised to "continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets" (see story).

According to the minutes of the meeting, "a few" of the committee’s 12 members "observed that it might become desirable at some point in the future to provide more policy stimulus by expanding the planned scale of the (MBS purchases) and continuing them beyond the first quarter, especially if the outlook for economic growth were to weaken or if mortgage market functioning were to deteriorate."

Some members of the committee still viewed the improved outlook for residential real estate "as quite tentative," pointing to "potential sources of softness, including the termination next year of the temporary tax credits for homebuyers and the downward pressure that further increases in foreclosures could put on house prices," the meeting minutes said.

But one member of the committee thought "improvement in financial market conditions and the economic outlook suggested that the quantity of (MBS purchases) could be scaled back, and that it might become appropriate to begin reducing the Federal Reserve’s holdings of longer-term assets if the recovery gains strength over time." …CONTINUED

Some economists are worried that actions the Fed took to stimulate the economy during the financial crisis will overheat the economy and produce another asset bubble or lead to inflation if policymakers don’t begin to unwind them soon.

In a Jan. 3 speech, Federal Reserve Board Vice Chairman Donald Kohn said the Fed "will need to begin withdrawing extraordinary monetary stimulus well before the economy returns to high levels of resource utilization."

Kohn said the Fed could sell portions of its holdings of MBS, Fannie Mae and Freddie Mac debt, and Treasury securities "if we determine that doing so is an appropriate approach to tightening financial conditions when the time comes."

If the Fed were to begin selling Fannie, Freddie and Ginnie Mae MBS it holds, rather than continue to purchase them, that could depress prices for those securities and send mortgage rates up.

In a Dec. 8 forecast, the Mortgage Bankers Association projected rates on 30-year fixed-rate mortgages will rise for the next eight consecutive quarters, from an average of 4.9 percent during the final quarter of 2009, to 6.2 percent by the fourth quarter of 2011.

Rates for 30-year fixed-rate mortgages increased from 4.92 percent to 5.18 percent over the holidays, the group said (see story).

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