The Fed was right about some of its stimulus policies, basically.
A new study shows that the Federal Reserve’s bond-buying stimulus program, which has kept mortgage rates artificially low for the past four years, had a measurable, positive impact on American households and the economy.
Of course, it didn’t work in the exact way the Fed hoped. Lower interest rates on mortgages didn’t necessarily lead to broad, increased spending or even boost home sales, but they did give homeowners a little extra cash flow.
The authors found several benefits to the policy, writing that a “sizable decline in mortgage payments ($150 per month on average) induces a significant drop in mortgage defaults, an increase in new financing of (auto purchases) of more than 10 percent in relative terms and an overall improvement in household credit standing.”
“You have to look at the relative magnitude of this effect,” says Tomasz Piskorski, an author of the study Mortgage Rates, Household Balance Sheets and the Real Economy. “If you lower the cost of servicing for homeowners, they’re going to have more money and they’re going to do something with it. What they do is important. That impacts the magnitude of the policy.”
Because lower interest rates allowed homeowners to refinance and reduce their monthly payments, many were able to stay in their homes. According to the study, a 20 percent reduction in monthly mortgage payments reduces the likelihood of mortgage delinquency by about 40 percent after two years.
What’s more, homeowner spending did help the economy and the bottom line of many households. An uptick in auto sales and a drop in household debt followed the reduced mortgage payments, according to the study.
“There was a thought that for distressed households, if you give them some extra money, they will essentially increase consumption,” says Piskorski. “But a lot of these households are saddled with lots of credit card debt with interest rates at 15 or 16 percent, and that’s not tax deductible,” unlike mortgage interest.
Homeowners generally used the extra cash to pay off debt. In fact, 70 percent of the money they saved on monthly mortgage payments went toward paying off debt. While it may seem that money simply winds up back with credit card companies, it actually helps save households money, which means higher cash flows in the future, Piskorski says.
Even without the trickle effect, the study shows that about 30 percent of what the homeowners saved on their mortgages did wind up going back into the economy right away. It’s not a huge boost in economic consumption, but it’s not negligible either.
Much of the money homeowners saved on mortgage payments went toward the ailing auto industry. About 10 percent of it went toward purchasing a car. Those who had lower mortgage payments were also 11 percent more likely to purchase a car than those who didn’t.
For his part, Piskorski hopes that the Fed is conservative in rolling back its bond-buying program.
“A lot of this recovery might vanish as they do,” he says. “These are important effects.”
He also suggested that it might be a good idea for lawmakers to start looking into credit card interest rates. With lower rates there, households would have even more money to spend as consumers, boosting the economy further.