Monday, May 11, 2015

Mortgages, QE, and recovery

I have been watching for strong growth in mortgage lending as a signal of stronger real and nominal economic growth and interest rate increases.  There have been some signs of strength, but, so far, April real estate loans on the balance sheets of commercial banks has been weak, after a positive trend change through the winter.  (March was boosted by a technical change in the data, but still appeared to show a continuation of acceleration, which has disappeared in April.)  It could be that the MBS market is recovering, and a high proportion of net new mortgages are not staying on bank balance sheets.  Less than a quarter of residential mortgages are on bank balance sheets.  This is an easy weekly number to check, but it is incomplete.

The number for 2015 1Q housing debt in Tuesday morning's Household Debt and Credit Report may shed some light on this.  The Mortgage Bankers Association is showing strong Q1 activity, in both single family and multi-unit housing.

Here is a graph of the marginal change in Commercial & Industrial Loans and Closed End Residential Real Estate Loans on Commercial Bank balance sheets since the end of 2007.  I think we can see some of the idiosyncrasies of this recession in this data.  Notice that C&I Loans have grown at a very steady rate throughout the recovery, regardless of monetary policy.  I believe that is still the case, and that C&I Loans will continue to expand with little effect from early rounds of interest rate increases.

The real estate loans behaved differently.  Keep in mind that they should have been increasing at a rate slightly higher than C&I Loans.  I have previously wondered about the decline in bank lending concurrent with QEs.  But, on further reflection, I think what we are seeing there is that during QEs, cash was making its way into the real estate asset class. All-cash investors were buying homes from overleveraged households.  This process was accelerated during QEs.  As QEs were ended or tapered, this activity declined or grew at a slower rate, and new mortgage originations once again would begin to push mortgages outstanding higher.  This happened as QE3 tapered, but mortgages at the banks leveled off at the end of 2014.  A new rise in these loans is one signal I am looking at.  This recovery is mostly about getting capital back into real estate.

Over the past year or so, the Fed has been testing out its Reverse Repo program, which is a roundabout way of pulling reserves back out of the banks and selling treasuries back into the private market.  Reverse Repos on the Fed balance sheet increased by about $150 billion.  In effect, they temporarily sold $150 billion of treasuries back to private investors.  Do any readers have any thoughts on this?  Could this program have had a disinflationary effect that might explain some of the nominal pullback of the past several months?

In addition to the several mortgage indicators I am watching, I noticed another piece of bank balance sheets that appears to have systematic behavior - the portion of bank assets held in securities in bank credit, which is mostly treasuries and agency securities.  Banks buy more of these low risk securities during stressful times and decrease their relative holdings during expansions.  The peak in these securities tends to come within a few months of the first interest rate hike.  (In the graph, the proportion of bank assets in these securities is inverted, to help show the pattern.)  This seems intuitively reasonable, as both the rise in risk free interest rates and the decline in low risk securities on bank balance sheets would both reflect a higher relative demand for riskier investments.

In the close-up version of the graph, we can see more recent behavior.  These low risk securities peaked as QE2 was implemented and began to decrease, only to recover to higher levels after QE2 was terminated.  Then, it peaked and decreased with QE3, but with a much weaker decline.  And, then, again, as QE3 was tapered, bank holdings of treasuries and MBS began to rise again.  But, there just now are the slightest indications of a decline.  Maybe this is not really a separate indicator.  The marginal new bank assets replacing these assets will probably be real estate loans.

Update: The NY Fed Household Debt numbers are out.  Housing debt was up about $40 billion flat for the quarter.  Technically growth and acceleration, but still in rounding error territory.


  1. So you have pre 2007 data for bank assets so we can see what "normal" looks like?

    1. Here's a long term graph. C&I Loans recovered unusually quickly. Nominal levels tend to rise with NGDP. Mortgage levels have never really declined before or remained level for so long. Of course, they were higher than usual in the 2000s, compared to NGDP, and a correction from that level may be inevitable, but it would be associated with a rise in real long term interest rates in a functional equilibrium state.: