Federal Reserve Bought Up Asset-Backed Securities As China Sold Following Financial Crisis

Asset-backed securities, specifically mortgage-backed securities, were at the center of the 2007-2008 financial crisis. These were the investments created by the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, by pooling together mortgages and then selling slices or tranches of pooled mortgages to investors in the open markets.

China, as well as Taiwan and Japan, had been on a spending spree for asset-backed securities throughout the early 2000s. China, by far the largest foreign holder of agency debt, increased their portfolio from almost nothing in 2000 to almost $500 billion according to the U.S. Treasury’s report on foreign holdings. It’s not specified how much of those asset-backed securities were mortgage-backed securities and how many of the mortgage-backed securities would be issued by Fannie Mae and Freddie Mac, although the GSEs are by far the largest issuer of mortgage-backed securities.

As the financial crisis took hold and yields on mortgage-backed securities began collapsing, ratings agencies, like Moody’s, S&P, and Fitch, downgraded the GSE’s mortgage-backed securities. Institutional investors, like pension funds, are often required to only hold debt of a high rating, so the downgrade would effectively force those investors to sell their holdings.

To staunch the supposed contagion and preserve the GSEs, the housing market, and the financial markets in general, the Federal Reserve—the central banking system of the U.S. comprised of private banks—stepped in and bought up huge swaths of mortgage-backed securities as major investors like China were liquidating their positions.

All in told, the Fed purchased $1.25 trillion in agency mortgage-backed securities during that time, plus another $500 billion soon after. One-fifth of that, or about $250 billion, is what China sold during that time. The Fed is now the largest holder of mortgage-backed securities.

Collapse in Commercial MBS, Not Agency MBS

Despite all of the fear of a collapsing housing market, housing prices recovered in a few years to what they would have been without a crisis. Similarly, the agency MBS market—mortgage backed securities issued by the GSEs—had a temporary blip, but recovered substantially soon after. There is now approximately $1 trillion more in agency mortgage-backed securities issued than there was at the height of the housing crisis according to numbers from the non-profit Securities Industry and Financial Markets Association (SIFMA) that represents the securities brokerage industry.

Yet it was commercial mortgage-backed securities, issued by banks and other financial institutions, that would see a collapse that has yet to recover.

Since the financial collapse, there have been innumerable lawsuits against banks and various other investment organizations over how mortgage-backed securities as well as other derivatives based on those assets were bought and sold. In 2018, Wells Fargo paid $2.8 billion for misrepresenting the quality of loans in their mortgage-backed securities. Goldman Sachs paid $5 billion in 2016.