Calculated exuberance: Monetary policy and the Great Recession

This study uses a factor-augmented vector autoregression (FAVAR) methodology to determine if monetary tightening induces the government-sponsored entities (GSEs) to increase their sale of qualified mortgages in the primary securitized capital markets in a way that induces greater private-label securitization over both the pre-crisis (1995--2006) and crisis/post-crisis (2007--2015) periods. FAVAR model estimation uses 423 series, and two main sites provide most of the data series: the Federal Reserve Economics Database (FRED) and IHS Global Insight. To measure securitization and real estate investment trust (REIT) activity, data sources include the Federal Reserve Flow of Funds, Securities Industry and Financial Markets Association (SIFMA), and the National Association of Real Estate Investment Trusts (NAREIT). If private investors and other parts of the shadow banking system ignore the Federal Reserve's inflationary pressure signals as reflected by a 25 basis point rise in the shadow monetary policy rate because of the GSEs' activities in the originating capital markets, both agency and private-label transaction volumes should move in the same direction in both time periods. The empirical analysis also investigates whether bank and nonbank lending along with REIT equity and debt issuance decline after an increase in the shadow policy rate for both the residential and commercial real estate sectors over the same time periods. Including nonbank lending and REITs controls for the different ways liquidity is inserted into the real estate economy. Evidence that the GSEs could have possibly misled market participants, including the private-label securitized capital markets, is consistent with the increasing volume of agency transactions in the primary capital markets when bank and nonbank lending decreased either prior to or after the Great Recession. It is important to differentiate between periods because the Federal Reserve also began trading mortgage-backed securities (MBS) in the secondary capital market after 2006. We find that GSEs do not distort the real estate economy through participation in securitization capital markets following a monetary tightening. From 1995 to 2006, originations of agency securitized mortgages rise, but private-label securitized mortgages are unaffected. The GSEs counteract a monetary contraction by maintaining mortgage levels through the shadow banking system in a period of opaqueness. After 2006, in contrast, originations of private-label securitized mortgages increase briefly, while agency securitized mortgages fall. Thus, investors continue to buy private-label securitized mortgages during a period of greater transparency after the recession for higher yields and separate from GSE market intervention.