17  Of course, this maturity distribution could change as part of the Committee’s ongoing assessment of the economic outlook and the efficacy and costs of asset purchases. 6  BIS central bankers’ speeches  issuance of coupon securities.18 We have a larger presence in the market for longer-term securities, with SOMA holdings making up about 35 percent of securities with four or more years to maturity. The Committee carefully assesses the total amount, pace and composition of its purchases in part because it is aware of the potential for large-scale asset purchases to contribute to financial market dysfunction. Some on the Committee have listed financial market disruptions among the potential risks that they will consider as they evaluate the current purchase program. There is a finite supply of Treasury securities and agency MBS available to purchase, in terms of both total outstanding amount and how much is available for purchase in the market at any given time. If the Federal Reserve were to become too dominant a buyer or holder, it could reduce the tradable supply of these securities and discourage trading among market participants, leading to diminished liquidity and price discovery. A significant deterioration in liquidity could lead investors to demand a premium for transacting in these markets, ultimately raising borrowing costs and undermining the program’s policy goal.19 With this concern in mind, the Desk closely monitors how our implementation of asset purchases impacts financial market functioning.
Of course, buyers in a TBA transaction understand that sellers will look to exercise their option of delivering these relatively less valuable pools, and the price of the TBA contract will reflect the expected value of these securities. Market participants who wish to trade in MBS with more favorable prepayment characteristics do so in the “specified pool” market, where specific agency MBS are traded at prices quoted as a spread above the corresponding TBA. In other words, TBA prices serve as a benchmark for pricing all agency MBS. The standardized nature of TBA contracts helps make a large segment of the agency MBS market effectively homogeneous and thus highly liquid – an important characteristic for implementing large-scale purchases of agency MBS.8 Within the TBA market, the “production coupons” are the contracts in which the bulk of newly issued agency MBS are delivered and most trading occurs. The coupon rates on the production TBA contracts are linked to the primary mortgage rate. As a highly stylized example, say a mortgage originator plans to securitize a group of mortgages with an average primary mortgage rate of 4 percent. The originator pays a fee of about 50 basis points to Fannie Mae, Freddie Mac or Ginnie Mae, in return for a guarantee on the principal and interest payments of the underlying loans. The originator is also required to retain at least 25 basis points to cover costs associated with servicing the loan.