Why does monetary policy pay so much attention to housing? The easy answer over the last twelve years is the bubble. It was hard not to, though for a very long time policymakers did attempt a systemic disavowal. But beyond the middle 2000’s housing mania, central banks have had a very keen interest in real estate from the beginning.

The shorthand for monetary policy, meaning interest rate targeting, goes something like this: reduce the cost of funding, short end; steepen the yield curve which therefore makes it more profitable for banks to engage in lending. This is called a carry trade, or maturity transformation. The vast majority of bank lending is, surprise, mortgages.

But mortgage lending isn’t so simple and easy, and hasn’t been since securitization went into mass production (about the same time the mortgage-fueled housing bubble appeared in the latter half of the nineties). The shorthand therefore doesn’t really apply. And in mortgages, that’s really the case as I described several years ago in 2014:

First, you have to realize that the Fed through FRBNY’s Open Market desk doesn’t just buy some mortgage bonds as if they were like US treasuries. QE actually operates deep within the bowels of mortgage bond trading in a place called TBA. The entire purpose of the TBA market is to provide liquidity to something that is, at its core, completely and totally illiquid. A mortgage loan is about as static as it gets in banking.

What the Fed is buying through the Open Market Desk are largely “production coupons.” The TBA market is a highly standardized operation allowing millions of individual mortgage loans to be packaged into MBS securities in such a fashion that these otherwise immovable loans can be turned to cash in a moment’s notice. But mortgage originators need to “buy” GSE guarantees and factor that cost into the setting of MBS prices (along with a set aside for servicing costs). So whatever the net yield on the mortgage pool, say for argument’s sake it is 5%, the originator will pay 50 bps to the GSE for its guarantee, set aside 25 bps for servicing costs and then subtract its own spread. If that profit spread is 25 bps, the “production coupon” that is left is 4% to the market.

The Open Market Desk’s purchase of production coupons amounts to a retail purchase out of what is really a wholesale product. The generic ideal is that by purchasing more production coupons than might have otherwise been bought it will allow more room for originators to pocket a spread. In other words, if the Fed purchases bump up demand to the point that the “market” is competing for production coupons at 3.75% instead of 4%, the originator can gain some additional bps in profit spread and even pass some of those savings to new mortgage loans in the form of lower interest rates. The increased spread should, theoretically, entice more participation and increase production of mortgage loans to add to the TBA pool (because there is more profit to be had).