“The Federal Reserves asset purchase programs were designed to remove risk from the portfolios of private investors. For example, Treasury and agency MBS purchases remove duration risk, thereby lowering longer-term interest rates and reducing private sector borrowing costs. Furthermore, agency MBS purchases also remove prepayment risk in the market. Since homeowners can prepay their mortgage at any time, MBS investors do not know when they will receive their cash flows. Investors generally demand an extra return to bear this risk, which is incorporated into MBS yields and in part passed along to borrowers. The removal of a considerable amount of this risk by the Feds purchases would be expected to lower MBS rates by lowering this extra return, thereby reducing primary mortgage rates, stimulating demand for housing and prompting increased refinancing activity.”
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