Mortgage Refinancing And Money Demand |
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The connection between
mortgage refinancing and liquid deposit growth is a stock adjustment process wherein the stock of liquid deposits responds directly to the changes in the flow of refinancing. When the rate of growth of mortgage refinancing increases, as it did during late 1991, the third quarter of 1992 and the second quarter of 1993, liquid deposit growth accelerates. When refinancing continues at a higher rate and deposit levels converge to the new level that was expected, the deposit growth slows down. When mortgage refinancing activity subsides, as it did in mid-1992 and early 1993, liquid deposit growth slows down further and deposits diminish. Mortgage refinancing sharply increased the volatility of M1 through its effect on liquid deposits during 1986-87 and 1991-93. M1 is the amount of money in circulation equivalent to cash + regular demand deposits + other check-type deposits. At the same time, the volatility of the broader aggregate M2 was only marginally affected. M2 is equivalent to M1 + savings and small denomination time deposits. In broader terms, the lower sensitivity of M2 to mortgage refinancing reflects the much smaller share of transaction deposits in M2 (about 20%) than in M1 (about 70%). The small changes that appears in the volatility of M2 closely resembles the changes in its non-M1 component. The mortgage refinancing can affect the level and volatility of liquid deposits and M1. This is partly due to the borrowed reserves operating procedure used by the Federal Reserve to control the growth of M2. During the last decade, this operating procedure has largely evolved into one that closely stabilizes the federal funds rate at a level that is thought to be consistent with the desired amount of discount window borrowing and the growth of M2. To maintain the desired levels of the federal funds rate and discount window borrowing, transitory increases in the demand for reserves are automatically accommodated with increases in the supply of non-borrowed reserves. The Role Of Mortgage Securitization Because of the upsurge in mortgage securitization during the last decade, the capability of mortgage refinancing to affect the growth of the monetary aggregates has remarkably increased. The sale of mortgages in the secondary market creates an additional financial instrument, the mortgage-backed security also called the MBS. This involves a number of additional firms in the mortgage process, including the originators of the mortgages, the assembler of the mortgage pool (the one who also issues the MBSs), the serviceman of the mortgage pool (who collects monthly payments and disburses funds to the investors) and at least one government agency. As per the law, securitization of mortgage refinancing involves combining a fixed pool of mortgages into a trust. The mortgages serve as collateral for MBSs sold against the trust. As a trustee, the serviceman of the MBSs collects payments from the homeowners and passes them through to the holders of the MBSs without taxation. Obtaining a third-party guarantee enhances the liquidity of the MBSs. This would cover the payments due to the investors provided the homeowners make payments at the scheduled, minimum contract rate. Three federal-government-sponsored enterprises, also known as agencies, dominate this business. These agencies guarantee the payment of principal and interest on securities backed by pools of specified mortgages for a specified amount of fees. The Government National Mortgage Association (Ginnie Mae, or GNMA), a part of the Department of Housing and Urban Development, guarantees payments on MBSs backed by pools of Federal Housing Administration (FHA) and Veterans Administration (VA) mortgages. The monetary control operating procedure used by the Federal Reserve primarily affects the impact of mortgage refinancing related transactions on the demand for liquid deposits and the monetary aggregates. The refinancing of securitized mortgages generates temporary increases in the demand for liquid deposits. Since these deposits are subject to non-zero reserve requirement ratios, the Federal Reserve accommodates this demand under its current monetary control procedures by furnishing additional reserves. This is mainly to maintain the federal funds rate close to the level expected to be consistent with desired longer-run growth of M2. When final payments to MBS investors are completed, both the quantity of liquid deposits demanded and banks" required reserves fall. To maintain the desired level of the federal funds rate once again, the Federal Reserve withdraws the now-surplus reserves from the market. |
