QE3 Moves Freddie Mac Economists to Revisit Projections

Freddie Mac is revisiting its economic projections for the remainder of 2012 and 2013 due to the announcement by the Federal Reserve of its Maturity Extension Program known as "QE3."  Under the program the Fed will increase its purchases of agency mortgage-backed securities (MBS) by $40 billion per month while continuing the term extension (also known as Operation Twist) of its portfolio.  Taken together the two programs will increase the Fed's holdings of longer term securities by about $85 billion through the end of 2012.   

The Fed hopes to encourage lower long-term interest rates, especially on fixed-rate mortgages and through them stimulate further housing market activity.  Moreover, the increased housing demand stimulated by QE3 may partly offset (albeit by a small amount) the substantial reduction in 2013 aggregate demand that would be expected if the so-called "fiscal cliff" occurs.

Freddie Mae points to the housing sector's performance in the recovery from the recession as unlike any other recovery over the last 65 years; it did not lead the recovery but has lagged it.  "In fact, residential fixed investment (RFI) (the component of gross domestic product (GDP) that includes expenditures on new housing construction, additions and alterations to the existing housing stock, and broker commissions on property sales) was a net drag on GDP growth during 2006-2010 and added less than one-tenth of a percentage point to GDP growth in 2011."

This year, however RFI added 0.3 percentage points to the first-half 2012 real GDP growth of 1.7 percent (annualized) and will likely add similarly during the second half of the year.  The gradual turnaround in housing activity reflects, in part, the Feds accommodative monetary policy. With mortgage rates at their lowest levels since at least the 1940s, housing demand has begun to improve. New housing starts were up 25 percent and existing home sales gained 8 percent over the first eight months of 2012 compared with the same period last year.

Property value indexes for the U.S. have also turned up, with the FHFA purchase- only house price index up 3.8 percent over the 12 months through July and the National Council of Real Estate Investment Fiduciaries' value index for apartment buildings up 7.6 percent over the four quarters through mid- 2012.

The rates have also spiked a refinance boom which accounts for roughly three-fourths of all loan applications this year.  Freddie Mac's refinancings have lowered rates for the average borrower by about 1.5 percentage points saving an average of $2,100 a year for a borrower with a $200,000 loan.  The company's new projection has about 7 million borrowers refinancing over the next year which, if this reduction holds, will result in $15 billion in mortgage payment savings, a substantial infusion of funds to help strengthen savings and consumption spending by owners.

Freddie Mac boosted its projection of single-family mortgage originations for the remainder of this year and to 2012 first because the September release of the 2011 Home Mortgage Disclosure Act (HMDA) data led to an upward revision in estimates of 2011 origination volume.  Lenders covered under HMDA reported $1.43 trillion in originations in 2011 which, extrapolated to all lenders, equates to about $150 trillion.  This larger volume for 2011 also increased estimates for 2012 which are based in part on estimates of purchase-money and refinance growth between the two years.

Second, the expectation of an extended period of low mortgage rates ushered in by QE3 has caused an increase in the new purchase-money and refinance volume during the second half of 2012 and into 2013. Freddie Mac says it expects single-family origination volume to come in close to $2 trillion in 2012, about a 30-percent rise from 2011, and then drop by 15 to 20 percent in 2014 as refinance 'burnout', somewhat higher mortgage rates, and the scheduled expiration of HARP lead to substantially less refinance activity.

Freddie Mac's economists say the QE3 initiative will take on even more importance if the assortment of temporary tax cuts are allowed to expire at year-end and government spending levels are reduced with the start of 2013.  These "fiscal cliff," items include (but are not limited to) the expiration of the 2 percentage-point payroll-tax cut and Bush-era tax-rate reductions, and the spending cuts related to long-term unemployment benefits and automatic reductions required under the Budget Control Act of 2011.

The Congressional Budget Office has estimated that if all the temporary tax cuts expire and government spending levels are reduced, that 2013 GDP growth would be reduced by at least 2.2 percentage points from what it otherwise would have been, possibly pushing the U.S into recession with unemployment rising to 9 percent. Moody's Analytics also concluded the economy would be much weaker in 2013 in such a scenario, with growth estimated to be 2.8 percentage points slower and unemployment rising to 9.2 percent.1 With QE3 already in place and helping to bolster housing demand in the near term, the economic effects of experiencing the "fiscal cliff" will be somewhat less than they otherwise would be.