Monetary Policy: Operation Twist Extended

Monetary Policy: Operation Twist Extended

by Robert Dietz — Eye on Housing

On Wednesday, the Federal Open Market Committee (FOMC), the branch of the Federal Reserve that determines monetary policy, announced an extension of the ongoing policy sometimes referred to as “operation twist.”

This policy seeks to keep long-term interest rates low, thereby stimulating the economy, by selling Treasury securities with short maturities (three years or less) and purchasing Treasury securities with maturities ranging from six years to 30 years.

The extension will result in a continuation of present policy and result in the additional exchange of short-term securities for long-term securities of an amount totaling $267 billion through the end of 2012.

The FOMC sought to extend current policy because of downward revisions to its economic forecast. In particular, the Fed has reduced its GDP forecast range for 2013 from a range of 3.1% to 2.7% as of April to a range of 2.2% to 2.8%. For unemployment, the revision from the April forecast was similarly negative: from a range of 7.3% to 7.7% for 2013 to a range of 7.5% to 8% as of the June forecast.

Extension of operation twist will have only indirect effects on mortgage rates and housing. That is, to the extent that the policy improves economic growth and employment, the extension will have a positive impact on housing. But the more binding constraint with respect to housing finance is access to mortgage debt, rather than mortgage interest rates.

Indeed, tight credit standards were highlighted by an article in Fortune on Thursday morning. The article demonstrated that while credit terms were easing for credit cards and auto loans, access to mortgages remains restrictive.

For example, the article noted that in 2011 households with credit scores of less than 700 obtained auto loans totaling $169 billion, an increase of 26% year-over-year. However, despite record housing affordability, credit standards are tighter today than 2007. Citing aFederal Housing Finance Agency conservator report, the Fortune article reported that in 2007 the average Fannie Mae backed loan had an loan-to-value (LTV) ratio of 75% and a credit score of 716.  For 2011, the average LTV fell to 69% (thus involving larger downpayments) and the average credit score had increased to 762.

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