The Fed's MBS Balancing Act: Rate Suppression and Housing Market Distortions

The Federal Reserve's mortgage-backed securities (MBS) purchase programs have long been a double-edged sword. On one hand, they stabilize financial markets during crises and suppress mortgage rates, making homeownership more accessible. On the other, they risk distorting housing fundamentals by creating artificial demand for MBS and decoupling mortgage rates from organic market forces. As of September 2025, the Fed holds $2.3 trillion in agency MBS-nearly 30% of the outstanding market-while its reinvestment strategy into Treasury securities has further complicated the relationship between monetary policy and housing affordability, according to a Federal Reserve note.

The Mechanics of Rate Suppression

The Fed's MBS purchases operate through a combination of liquidity provision and yield compression. By buying large volumes of agency-backed securities, the Fed reduces risk premiums embedded in mortgage rates. For instance, during the 2008 financial crisis, its MBS program lowered mortgage rates by approximately 100 basis points, with half of the decline attributed to improved market functioning and the other half to portfolio rebalancing effects, according to a Fed study. In 2025, similar dynamics are at play. The Fed's reinvestment of $35 billion in monthly MBS runoff into Treasuries has indirectly suppressed mortgage rates by keeping Treasury yields lower than they might otherwise be, the Fed's Implementation Note explains. However, this effect is muted by the fact that fixed-rate mortgages are more closely tied to long-term Treasury yields than the federal funds rate, as shown in a CBS News analysis.

The result is a paradox: despite the Fed's rate cuts in late 2025, the 30-year fixed mortgage rate remains stubbornly high, hovering near 6.35% in September 2025, per Eye On Housing. This is because market participants have already priced in much of the Fed's easing, and broader factors-such as inflation expectations and housing supply constraints-continue to weigh on rates, Morgan Stanley notes in its analysis of mortgage-rate drivers Morgan Stanley. A 100-basis-point drop in mortgage rates, to around 5.5%, would likely be needed to stimulate meaningful home sales growth in 2026, according to a PIMCO analysis.

Distorting Housing Market Fundamentals

The Fed's interventions have also created structural imbalances in the housing market. By maintaining a floor under MBS prices, the Fed has reduced the natural ebb and flow of supply and demand. For example, during the 2022–2024 quantitative tightening (QT) phase, the Fed's reduced MBS purchases led to a six-fold increase in MBS yields and a sharp rise in mortgage rates, exacerbating affordability challenges, according to a Forbes article. Today, the spread between the 30-year mortgage rate and the 10-year Treasury yield has widened to historically high levels, exceeding 2.3 percentage points, a divergence highlighted by Wolf Street. This divergence reflects a market struggling to reconcile the Fed's dual mandate of price stability and maximum employment with the realities of a housing sector where one-sixth of economic activity is at stake, as detailed in a Bank of America analysis.

Moreover, the Fed's focus on reinvesting MBS runoff into Treasuries has inadvertently starved the MBS market of liquidity. PIMCO analysts argue that reinvesting the $18 billion in monthly MBS runoff into new mortgage securities could compress mortgage spreads by 20–30 basis points-a more direct easing effect than a 100-basis-point cut to the federal funds rate. Bank of America has even suggested that a return to MBS quantitative easing, coupled with yield curve control, could drive the 10-year Treasury yield down to 3.00%–3.25%, paving the way for a 5.0% mortgage rate by 2026.

The Path Forward: A Delicate Tightrope

The Fed faces a daunting challenge in balancing its inflation-fighting mandate with the need to avoid further destabilizing the housing market. Its current approach-allowing MBS holdings to roll off its balance sheet while reinvesting proceeds into Treasuries-has created a situation where mortgage rates are both artificially suppressed and unresponsive to traditional monetary policy tools, as the Fed's Implementation Note explains. This asymmetry is particularly problematic given that housing affordability has deteriorated to its lowest level in decades, with monthly mortgage payments up 96.4% since January 2020, the Forbes analysis found.

One potential solution lies in leveraging the Federal Housing Finance Agency (FHFA) and the GSEs (Fannie Mae and Freddie Mac). These entities, with combined capital reserves of $154 billion, could purchase $50–100 billion in MBS to narrow mortgage-Treasury spreads without requiring regulatory overhauls, according to a Tomo blog post. Such a move would echo historical precedents, such as the GSEs' interventions during the 1998 LTCM crisis and the 2008 housing collapse, as outlined in a Stanford policy brief.

Conclusion

The Fed's MBS purchase programs have proven both a lifeline and a liability. While they have prevented a complete collapse in housing demand during crises, they have also created a dependency that distorts market signals and masks underlying affordability challenges. As the Fed navigates the delicate transition from QT to potential easing, its ability to recalibrate its MBS strategy will be critical. The housing market-and the broader economy-cannot afford another round of unintended consequences.