49

Richard C. Anderson

Richard fi Anderson is a research officer with the FederalReserve Bank of St. Louis. Heather Deaton providedresearch assistanca

The Effect of MortgageRefinancing on Money Demandand the Monetary Aggregates

ll~tONEY SERVES AS A medium of exchangefor transactions involving financial instrumentsas well as real goods and services. Unfortunately,the total volume of tt-ansactions iti the economyis not observable. As a result, economic analysesof rnomiev demand typically focus on the t-elation-ship between the quantity of money demandedand the production of new goods and services,measured by either gross domestic product orpersonal consumption expenditures. Because ag-gregate volumes of financial and nonfinancialtransactions likely move in par~tllelwith the out-put of new goods and services, the use of out-put rather than the volume of transactions maycost little in terms of understanding movementsin the monetary aggregates. In some periods,however, events occur which remind us thatthis is not always the case. This article examninesthe effect of one such ongoimig recent event—the refinancimtg of residential mortgages—on money demand.’

Simple models of the demand for money as amedium of exchange often implicitly assume thatthe purchase or sale of a good or service is com-pleted within a relatively brief period. Unlikethe transactiomis in these models, the refinancing

of a r’esidential mortgage that has been securi-tized in the secondary market initiates a sequenceof transactions that may continue for four to sixweeks, or niore. During this time, the quantityof liquid deposits demanded increases. When thelast transactiomi in the sequence is concluded,the quantity of deposits demanded falls backceterus paribas to its earlier level.

Mortgage refinancing is an important phenome-

non in the United States because most homesare financed with long-term, fixed-rate amortizedmortgages that contain a ‘‘put’’ option, allowingthe horrower to repay the outstanding principalamount of the loan at any time without penalt~’.Homeownet-s typically exercise that option whenmortgage rates fall significantly (1-2 percentage

1Other recent examples include the Tax Reform Act of 1986,which boosted household liquid deposits in late 1986 andearly 1987, and the closure of large numbers of thrifts bythe Resolution Trust Corporation. Recognizing that specialfactors can significantly distort growth of the monetary ag-gregates, the Bach commission recommended that theFederal Reserve regularly undertake and publish studies ofthe effects of special factors; see Report of the Advisory

Committee on Monetary Statistics (1976). The Bank ofEngland regularly publishes such analyses; see Pepper(1992, 1993) and Topping and Bishop (1989).

50

points) below recent previous levels by takingout a new mortgage loan to repay the old.As shown in figure 1,2 extensive mortgage re-financing has occurred during two periods inthe last decade, 1986—87 and 199 1—93. In theformer, an initial surge in refinancing during1986 was interrupted by a pause, before fearsof rising market rates launched a second roundin 1987. In the latter, three waves of refinancing—of increasing magnitude—mirm’om’ed the haltingfall in long-term market interest rates. During1992, for example, nearly one-fifth of all home-owners refinanced their mortgages.3 In 1993,the volume of refinancing activity will surpass1992’s record pace.

The next section of this article describes thechanges in the growth and volatility of liquiddeposits and Ml that have occurred duringperiods of extensive mortgage refinancing. Thearticle then examines the extent to which thesechanges may be related to increases in mortgagesecuritization. Finally, it explores whether recentfluctuations in the growth of other checkabledeposits (OCD5) since 1991 also may be relatedto mortgage refinancing.

MORTGAGE REFINANCING ANDMONEY DEMAND

The increases in liquid deposits that have ac-companied accelem’ations in mortgage refinanc-ing since mid-1990 are shown in figure 2. Thelink betweemi mortgage refinancing and liquiddeposit growth is a stock adjustment processwherein the stock of liquid deposits responds tochanges in the flow of m’efimiancings. When thepace of mortgage refinancing increases, as it did

during late 1991, the third quarter of 1992 andthe second quarter of 1993, liquid deposit growthaccelerates. As refinancings continue at thehigher rate, deposit levels converge to the newdesired level and deposit growth slows. Whenrefinancing activity subsides—as in mid-1992and early 1993—liquid deposit growth slows fur-ther and deposits may run off.

Through its effect on liquid deposits, mortgagerefinancing sharply increased the volatility ofMl during both 1986—87 and 1991—93, as shownin figure 34 At the same time, the volatility ofthe broadem’ aggregate M2, shown in figure 4,apparently was only slightly affected. In largepart, the lower sensitivity of M2 to mortgagerefinancing reflects the much smaller share oftransaction deposits in M2 (about 20 percent)than in Ml (about 70 percent). The smallchanges that do appear in the volatility of M2closely resemble changes in its non-MI com-ponent.5

The ability of increases in mortgage m’efinancingto affect the level and volatility of liquid depositsand Ml is in part due to the borrowed reservesoperating procedure used by the Federal Reserveto control the growth of M2. During the last de-cade, this operating procedure has largelyevolved into one that closely stabilizes the feder-al funds rate about a level thought to he consis-tent with the desired amount of discountwindow borrowing and the growth of M2. Tomaintain the desired levels of the federal fundsrate and discount window borrowing, transitoryimicreases in the demand for reserves are auto-matically accommodated with increases in thesupply of nonborrowed reserves.6

2ln the figure, the volume of refinancing activity is proxiedby liquidations of mortgage-backed securities, This conceptis explored further in this article.

3Nineteen percent of the homeowners interviewed in FannieMae’s 1993 national housing survey had last refinancedtheir mortgage between January 1992 and March 1993. Anadditional 3 percent had refinanced during 1991 and 1990.

4The coefficient of variation shown in the figure equals theratio of the standard deviation to the mean of the series,each calculated from the most recent 12 months of data,The coefficient of variation indicates whether the variabilityof the data has increased or decreased over time relativeto its average level.

5The volatility of M2 differs little from that of its non-MIcomponent. It is feasible that banks’ cash managementpractices might account for the insensitivity of M2 volatility.Increases in liquid deposits provide additional funds tobanks. If bank cash managers respond by reducing theirissuance of overnight repurchases (RPs), the change in thevolatility of M2 might be considerably less than that of Ml.

No such correlations between refinancing-related depositinflows and nontransaction funding sources are apparent inthe data, however.

6For an analysis of the borrowed reserves procedure and itsrelationship to federal funds rate targeting, see Thornton(1988). For a careful discussion of why and how reserves-based targeting procedures evolve into federal funds ratetargets, see Meulendyke (1990).

51

Figure 1Mortgage Interest Rate and Refinancing Activity

Monthly data, January 1984-September 1993Billions of dollars

** Liquidations of federal-agency-guaranteed mortgage-backed securities.

Figure 2Refinancing Activity and Liquid Deposits

Billions of dollars

50 -40—

30 —20 —10

~10

Monthly data, seasonally adjusted

11111J ASONDJFMAMJ JASONDJ FMAMJ JASONDJ FMAMJJ AS

1990 1991 1992 1993

Contract rate on 30-year, fixed

rate conventional mortgages(left scale)

Percent

16

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Change inLiquid Deposits

Index of mortgage~clngactlvlty**

I’d’rdt liii L I tillH

Liquid Deposits Demand Oeposits+Other checkable Deposits..- Savings and MMDA deposits

** Liquidations of federal-agency-guaranteed mortgage-backed securities.

52

Figure 3Refinancing and

Billions of dollars

25

20

15

10

5

0

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theVolatility of Ml

Monthly data, seasonally adjusted

Shaded areas are periods of heavy refinancing activity.

Figure 4Refinancing and

Billions of dollars

35302520IS1050-5

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the Volatility of M2

Monthly data, seasonally adjustedIndex

lB

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01984 85 86 87 88 89 90 91 92 1993

Index

18

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Shaded areas are periods of heavy refinancing activity.

53

THE ROLE OF MORTGAGESECURITIZATION

The increase in mortgage securitization duringthe last decade has increased the potential formortgage refinancing to affect the growth of themonetary aggregates.7 ‘The sale of mortgages inthe secondary market creates an additional finan-cial instrument—the mortgage-backed security,or NIBS—and involves a number of additionalfirms in the mortgage process, including theoriginators of the mortgages, the assembler ofthe mortgage pool (who also issues the MBS5),the servicer of the mortgage pool (who collectsmonthly payments and disburses funds to inves-tors) and, typically, at least one governmentagency. The refinancing of securitized mortgagesthus beconies a circuitous calling and refundingof relatively large amounts of long-term, publiclyheld debt. Elevated levels of liquid deposits maypersist for four to six weeks or more, until allrelated transactions are settled.

Legally, mortgage securitization entails com-bining a fixed pool of mortgages imito a trust.The mortgages serve as collateral for MBSs soldagainst the trust. The servicer of the MBSs, as atrustee, collects payments from homeownersand passes them through without taxation tothe holders of the MBSs. Liquidity of the MBSsis enhanced by obtaining a third-party guaran-tee covering the payments that will be due toinvestors if homeowners pay at the scheduled,minimum contract rate. Three federal-govern-mnent-sponsored enterprises, known as ‘agen-cies,” dominate that business.t For a fee, theseagencies guarantee the payment of principaland interest on securities backed by pools ofspecified mortgages. The Government NationalMortgage Association (Ginnie Mae, or GNMA),

a part of the Department of Rousing and UrbanDevelopment, guarantees payments on MBSsbacked by pools of Federal Housing Administra-tion (Fl-IA) and Veterans Administration (VA)mortgages. ‘T’he Federal National MortgageAssociation (Fannie Mae, or FNMA), a federallychartered, privately owned stock corporation,and the Federal Home Loan Mortgage Corpora-tion (Freddie Mac, or FHLMC), a wholly ownedsubsidiat’y of the federally charter’ed Federal1-lomne Loan Bank System, guarantee paymentson MUSs hacked by pools of conventionalmortgages.9

Absent refinancings or home sales, MBS in-vestors receive a monthl payment that includesthe scheduled amortization of the pool’s mort-gage principal plus the accumulated interest.Refinancings, home sales and an occasional ex-tra payment by a homeowner return additional(or unscheduled) principal pro rata to theholders of the MBSs backed by that mortgagepool. The monthly liquidation for a mortgagepool is the sunt of the scheduled and unscheduledprincipal payments returned to investors. Notethat MBSs aren’t “called” in the traditional senseassociated with corporate bonds, hut rather areonly proportionately liquidated or repaid.

As shown in the upper panel of figure 5, theoutstanding stock of MBSs increased about sixfold during the last decade, much more rapidlythan Ml or M2. With few changes in mortgageservicing rules and practices during the lastdecade, the rapid growth of securitization sug-gests that the transactions incurred in refinancingsecuritized mortgages will have larger effects onthe monetary aggregates in the 1990s than theydid in the mid-I 980s. Annual liquidations ofMBSs, shown in the lower panel of the figure,

7See Duca (1990) for an analysis of the interactions betweendemand deposits and mortgage refinancing during 1986—87.°Asmall amount or MBSs is issued without agency guaran-tees. Bank of America issued the first such private mort-gage pool in 1977. In 1992, private mortgage poolsrepresented only 8 percent of all outstanding pools. Forbackground, see Downs (1985) and Pavel (1986).

°Theprecise nature of the guarantee varies somewhat byagency. ONMA and FNMA guarantee timely (within themonth) payment of principal and interest, regardless ofpayments by the borrower, FHLMC guarantees timely pay-ment of interest and eventual (within the year) payment ofprincipal. In addition to issuing guarantees on MBSs backedby privately assembled mortgage pools, FNMA and FHLMCmay purchase mortgages outright and market MBSsbacked by pools of those mortgages. In 1992, for example,FNMA “issued” (guaranteed) $194 billion in MBSs. Of thatamount, about $13 billion were originated by FNMA itself;

the balance was originated by private lenders under aFNMA guarantee plan. FNMA’s 1992 Annual Report em-phasizes the off-balance-sheet contingent risk nature ofthese securities: “MBS are not assets of the corporationIFNMAI, except when acquired for investment purposes,nor are the related outstanding securities recorded as lia-bilities. However, the corporation is liable under its guaran-tee to make timely payment of principal and interest toinvestors. The issuance of MBSs creates guaranty fee in-come with Fannie Mae assuming credit risk, but withoutassuming any debt refinancing risk on the underlyingpooled mortgages.” In 1992, FNMA recorded $834 millionin guaranty fees.

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55

have on balance increased in proportion to theoutstanding stock except for significant surgesduring periods of refinancing. Annual liquida-tions iumped to ahout 17 percent of the out-standimig stock of Ntl3Ss during 1986—87 and 19percent during 1991—92. More recently, liquida-tions dut’ing June through September 1993averaged nearly $44 billion a month, almost a40 percent annual rate. Recent further decreases111 mot1gage rates portend continuing high liqui-dation rates during late 1993 and early ]994b0

‘I’he increase in deposits that follows an in-ct-ease in mortgage refinancing activity may in

part he traced to the mechanics of mortgagesecuritization and servicing. Mortgage servicers’handling of the unscheduled principal paymentsassociated with refinancings is governed by therules of the federal agency that guam’antees theMBSs issued against the mortgage pool. In gener-al, these rules require that mortgage servicershold unscheduled principal payments in specialcustodial accounts during the interval betweenreceipt from homeowners and disbursement toNIBS investors. GNMA requires that these cus-todial accounts be non-interest-bearing demanddeposits. FNMA allows funds to he held ininterest-bearing accounts as long as they are imn-mediately available without prior notice of with-dra’1val. FFILMC’s rules are similar to ENMA’s.

A surge in refinancing greatly increases themonthly average amount of funds held in liquiddeposits by a mortgage servicer. In a typicalmonth without refinancing, a set-vicer holds ahomeowner’s mortgage payment for a relativelybrief period of time (up to 15 days) beforeremittance to investors. Following a mortgagerefinancing, however, the servicer will hold theunpaid principal balance of the extinguishedmortgage loan—an amount perhaps 10 to 100(or- more) times as large as the homeowner’sregular monthly principal payment—in a cus-todial account for a much longer period, often

two to six weeks (see the shaded insert).”

Estimates of the size of this effect on monthlygrowth rates of demand deposits, Ml and M2,are shown in figure 6.12 When MBS liquidationsaccelerate, the growth rates of demand depositsand Ml after removing the MI3S effect aresmaller than the published growth rates. Con-ver’selv, when MBS liquidations slow, the NIBS-adjusted growth rates are larger than the pub-lished rates. Overall, the estimated differencesin growth rates equal in some months as mnuchas one-half of the change in MI. F’rom Decemher1991 to March 1992, for example, inflows tomortgage servicers’ custodial accounts are esti-mated to have added hetween 5 to 10 percentage

poitils to the monthly growth rates of demanddeposits. ‘l’he largest estimated effects were inOctober 1992 and May 1993, when MUS-relatedinflows likely accounted for four-fifths andthree-fifths, respectively, of demand depositgrowth. In both cases, deposit growth slowedsharply in later months when deposit levels hadincreased enough to support the accelera tedpace of mnortgage activity. Subsequemitly, duringthe first quarter of 1993, runoffs of servicers’custodial balances likely depressed monthlyaverage deposit growth by as much as 10 per-centage points.

‘these patterns show through to Ml (see thecenter panel of figure 6) but are muted. Curren-cy and OCDs, which comprise two-thirds of Nil,are unlikely to he affected by MBS activity.”Nonetheless, the distortions to demand depositsare sufficient that monthly growth rates of MIsince mid-1992 appear to ha~•’ebeen distortedby as much as 5 to 7 percentage IJoints. Similarestimates for M2 that include estimated effectson money market demand account (MMDA)balances are shown in the hottormi panel of thefigure.

Overall, fluctuations in mortgage servicers’

ttWhile it is always risky to forecast financial market activity,recent decreases in mortgage rates (through October 1993)are likely to trigger substantial further increases in re-financing and MBS activity during late 1993 and early1994. In addition to older mortgages issued during the1980s, mortgages that were issued as little as 12 to 18months ago at 7 to 7-112 percent rates now may profitablybe refinanced. Rather than the pace of refinancing slowingand related distortions to the monetary aggregates diminish-ing as the outstanding stock of seasoned MBSs are rolledover, recent rate decreases have placed nearly the entireoutstanding stock of MBSs “in the money” for rollover.

1tHomeowners typically make monthly mortgage paymentsbetween the 1st and 15th of the month, with the servicer

ing a refinancing, the funds received by the servicer fromthe homeowner (at any time within the month) are placedin a custodial account, These funds are remitted by theservicer to MBS investors after the middle of the followingmonth. The exact date, however, depends on the contractspecifications of the agency guarantee program underwhich the M8Ss backed by the mortgage pool that con-tained the extinguished mortgage were issued, See, for ex-ample, Karcher (1989).

“Construction of these estimates is discussed in the ap-pendix.

“The next section raises the possibility that OCD balancesalso might have been affected by refinancing since 1991,

remitting these funds to M6S investors on the 15th. Follow- albeit not through MBS-related transactions.

56

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custodial deposits likely account for about one- els. Also omitted are any increases in liquidhalf of the i ect nt increase in Ml volatility It is deposits that arise because of the stgnificantunlikely that these estimates ate too large, since volume of additional transactions used to pur-they are based on legal restrictions imposed on chase and sell large qu-intities of mortgages andmortgage servicers by federal agencies and NIBS.realistic but conservative assumptions regat dingintra month patterns of mortgage closings and HOUSEHOLD DEPOSITS ANDdeposit behavior.

REFINANCINGThe estimates may be biased dot~nwaid,

however, for a number of reasons. The most In addition to demand deposits, changes innportant perhaps is the omission ot any in OCDs since mid-1991 also have reflected the

crease in deposits held by issuers of new MBSs. ebbs and flows in the pace of mortgageAs some issuers draw on bank warehouse refinancing (ste the upper panel of figure 7).credit lines to fumJd the purchase of mortgages I lie apparent increase in the correlation ofto be assembled into new MBS pools, they may Of Ds with demand deposits contrasts with itsoffs.t part of the hank charges for these lines behavior before 1991 and during 1986—87, thevia earnings credits ha ed on their deposit let’ latter shown in the lower panel of figut e 7.

57

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Should some poi-tion of the OCD fluctuations to mortgage activity is necessar ilv less directduring 1991—93 be attributed to mortgage re- and more circumstantial than that for demandfinancing activity? If so, and if the impact of re- deposits. I racing direct links between house-financtng on OCUs were similar to its effect on hold deposits and economic activity is generallydemand deposits, then their combined effects not possible, since the Federal Reser~e collectscould account for as much as three-quarters of deposit data from the issuers of deposits such asMl’s growth during a number ol months since banks and thrifts rather than from the o~net s of1991. deposits, including households and firms.”

Ihe recent parallel monthly movements in Why might a household increase its OC I)these two types of liquid accounts i- compelling balances following a mortgage refinancin~Q Onehut puzzling. Any ct idence linking these deposits possibility could be thc convt m sion of home eq

“Although the Federal Reserve Boards flow of funds ac- for firms and government. See Guide to the Flow of Fundscounts present a fairly complete balance sheet for the Accounts, p. 120household sector, few items are directly observed Most en-tries are calculated as residuals, interred from the double-entry nature of the accounts and from balance sheet data

58

Figure 6Published Growth Rates Less Rate Adjusted for MBS Activity

Demand DepositsPercent

30

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1990 1991 1992 1993

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JASONDJFMAMJJASONDJFMAMJJASONDJFMAMJJAS1990 1991 1992 1993

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59

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60

uity into cash at the time of refinancing. Ifoperative, this factor should be much strongerduring the 1990s than during 1986—87, for tworeasons. First, many households have been res-tructuring their balance sheets, seeking to reducethe levels of debt (and debt service) that theytook on during the 1980s. Flomne equity convert-ed to cash at refinancing allows them to repayother outstanding debt and reduce monthlydebt service. Second, households generally ex-perienced large capital gains on houses duringthe 1980s. For many, capital gains in housingappeared largely as a windfall, accruing mom-crapidly than had been anticipated when thehome was purchased and without any overt ef-fort by the homeowner. As such, these in-creases in wealth likely were not optimallydeployed (from a portfolio standpoint) across allhousehold asset categories. For other home-owners who nught have preferred to consumethe increased wealth rather than save it, thecapital gain appears as a type of forced savingin the form of home equity. While a home equi-ty loan may increase the liquidity of home equi-ty, it doesn’t permit the household to consume awindfall increase in home equity, since the loanmust be repaid. Flence, there may be somepent-up demand by homeowners for redirectingpart of their home equity toward balance sheetrestructuring (reducing other consumer debt),consumption or perhaps redeployment intomore liquid assets.

Although no direct data on cash withdrawalsat mortgage refinanciugs are available, recentevidence is supportive. Fannie Mae’s 1993 na-tional housing survey asked households whethertheir primary motivation in refinancing was toshorten the maturity of the loan (thereby build-ing equity more quickly) or to reduce theirmonthly payments. While a shorter maturitywas the motive more frequently stated, in fact

at refinancing more households tended to foregoa shorter maturity in favor of lower monthlypayments, consistent with reducing the impor-tance of home equity in their portfolios. (Unfor-tunately, the survey did not ask about thewithdrawal of home equity at refinancing.)Home equity lending at banks, shown in figure8, also has been weak since mid-1991, withreports suggesting that homeowners are indeedrepaying outstanding home equity loans withcash withdrawn at the time of a mortgagerefinancing.

While the growth in OCDs likely reflectschanges in households’ deposits, some profes-sionals and small businesses also may accountfor a portion of the increase. Some real estatepayment practices tend to increase the demandfor OCDs when mortgage activity increases. I’he1969 Truth in Lending Act, for example, im-plemented through the Federal Reserve’s Regu-lation Z, requires a three-day, right-of-rescissionperiod for any new credit transaction securedby the borrower’s principal residence.’~Duringthis period, settlement agents typically holdfunds in a liquid deposit, or perhaps in theform of cashier’s and officers’ checks. If thefunds are held solely for the beneficial interestof the household, they may he placed in anOCD account.’°Cashier’s and officers’ checksissued by banks are included as demand depositsin Ml, while such checks issued by thrifts typi-cally are included in OCDs.

This supportive yet largely circumstantial evi-dence leaves a number of unanswered questions.If a household extracts funds at refinancing torepay a home equity loan, how long will it keepthe funds in a liquid deposit? And isn’t theamount of funds almost surely far smaller thanthe amounts held by mortgage servicers, associ-ated with MBS refunding activity? If so, can the

“These provisions do not apply to home purchases, nor torefinancings with the same lender for an amount equal toor less than the unpaid principal balance. The Act exemptsfrom right-of-rescission provisions residential mortgagetransactions’ which are defined in the Act as extensions ofcredit to acquire a principal residence. In May 1987, at therequest of mortgage market participants, refinancings withthe same lender were exempted from Regulation Z. At thetime, it was felt that this change likely would significantlyreduce the number of refinancings subject to right-of-rescission provisions.

160n the eligibility of lawyers to hold a client’s funds in OCDdeposits, see section 2-341 of the Fed’s Regulation 0 inFederal Reserve Regulatory Service (1993). Client fundsalso may be placed in MMDA deposits, although the rul-ings contained in section 2-341 perhaps suggest a prefer-

ence to hold the funds as OCOs. OCDs have no restrictionson the number of third-party withdrawals per month. Whileboth OCDs and MMDA deposits are included in M2, dataon MMDAs have not been collected by the FederalReserve System since September 1990. Banks and thriftsbegan reporting that month only a combined total for allsavings and MMDA deposits. Hence, no separate analysisof MMDA deposits is shown in this article.

61

II liii Iii till Ill liii II liii iii liii ill

JASONDJ EMAMJJASONDJFMAMJJASONDJ FMAMJJA1990 1991 1992 1993

increasingly parallel movements in OCDs reason-ably he attributed to refinancing activity? Onbalance, while the sharp increase in the correla-tion between the changes in OCDs and demanddeposits since 1991 suggests an underlying rela-tionship to mortgage refinancing, the magnitudeof any effect on the monetary aggregates remainsuncertain and a convincing explanation elusive.

SUMMARY

Any factors that increase the demand for trans-action deposits can distort the growth of themonetary aggregates over significant periods oftime. Recent waves of mortgage refinancing ac-tivity have caused significant fluctuations in li-quid deposits and Ml. Under current FederalReserve operating procedures for controlling thegrowth of M2, such transitory changes in thedemand for liquid deposits, like those associatedwith mortgage refinancing, at-c automatically ac-commodated through changes in bank reserves,leading to increased volatility of Ml -

A large portion of this increased volatility ofdemand deposits can be traced to fiduciary

rules governing the custodial accounts of mort-gage servicers. The mechanism generatingparallel high-frequency movements in OCDs,however, is far less clear. The coincidence of itstiming with changes in refinancing activity andthe onset of unusual weakness in home equitylending in 1992 suggest that it may be relatedto the ongoing restt’uctur’ing of householdbalance sheets during the 1990s.

REFERENCES

Board of Governors of the Federal Reserve System. FederalReserve Regulatory Service, volume 1 (October 1993).

_______ Guide to the Flow of Funds Accounts (Board ofGovernors of the Federal Reserve System, 1993),

“Improving the Monetary Aggregates;’ Report of theAdvisory Committee on Monetary Statistics (1976).

“Money Stock Revisions,” supplement to the FederalReserve statistical release, /1.6 (February 4, 1993).

Downs, Anthony. The Revolution in Real Estate Finance (TheBrookings Institution, 1985).

Duca, John V. “The Impact of Mortgage Activity on RecentDemand Deposit Growth,” Economics Letters (February1990), pp. 157—61.

Figure 8Refinancing Home Equity Lending

Billions of dollarsMonthly data

Billions of dollars

3

2.5

2

t5

1

0.5

0

-0.5

Index of mortgage

- bu

50

-40refinancing activity

Chan9e hi outstanding stock ~

commercial banks (left scale)

II

-

I

II III~ I -

0

10

62

Federal National Mortgage Association. 1992 Annual Report(Federal National Mortgage Association, 1992).

_______ Fannie Mae National Housing Survey 1993 (FederalNational Mortgage Association, 1993).

Karcher, Louis J. Processing Mortgage-Backed Securities(New York Institute of Finance, 1989).

Meulendyke, Ann-Marie. “A Review of Federal Reserve PolicyTargets and Operating Guides in Recent Decades;’ in Inter-mediate Targets and Indicators for Monetary Policy (FederalReserve Bank of New York, 1990), pp. 452—73.

Pavel, Christine. “Securitization;’ Federal Reserve Bank ofChicago Economic Parspectives (JulylAugust 1986),pp. 16—31.

Appendix

Pepper, Gordon, “Controls and Distortions: Monetary Policy inthe 1970s,” National Westminster Bank Quarterly Review(February 1992), pp. 58—72.

“Monitoring the Money Supply and Distortions toMonetary Data;’ National Westminster Bank QuarterlyReview (February 1993), pp. 40—58.

Thornton, Daniel. “The Borrowed-Reserves Operating Proce-dure: Theory and Evidence,” this Review (JanuarylFebruary1988), pp. 30—54.

Topping, S.L., and S.L. Bishop. “Breaks in Monetary Series,”Bank of England Discussion Paper, Technical Series No.23 (February 1989).

Estimates of Mortgage Servicers’ CustodialAccount BalancesThis appendix employs methodology suggested

by Duca (1990) to estimate the impact of re-financing on the amount of liquid deposits heldby mortgage servicers.1 At refinancing, the out-standing principal of an extinguished securitizedmortgage is returned to the mortgage servicer.Following rules established by the federal agencythat guaranteed the MI3Ss issued against the poolcontaining the mortgage, servicers place incom-ing unscheduled payments in custodial accounts(liquid deposits) until remnitted to the holders ofthe MBSs around the middle of the followingmonth. Since the servicing rules of the threeagencies differ, the overall increase in custodialdeposits that follows an increase in refinancingdepends on the agency composition of MBS liq-uidations. Differences in this composition during1991—93 relative to earlier periods have attenu-ated the deposit impact of recent MBS liquida-tions from what might have been expected.GNMA-guaranteed issues made up about one-half of aggregate liquidations during 1986—87,

for example, hut only one-quarter in 1991—93.The largest volumne of liquidations during1991—93, on balance, has been FFILMC issuesthat have a smaller impact, dollar for dollar, onliquid deposits than liquidations of GNMA- orFNMA-guaranteed MBS.

‘the increase in liquid deposits due to MRS liq-uidations is estimated from a simple simulation.The parameters are’:

The proportion of MRS liquidations during amonth that result from scheduled amortizationof principal (not-rn hq}. Separation of sched-uled from unscheduled payments mailers forreasons explained in the text. Estimates in thisarticle assume that scheduled principal pay-ments equal 1 percent tat an annual rate) of theoutstanditig stock of MBSs.2

The average number of days, expressed as a pro-portion of the month, that unscheduled principalpayments are held in custodial accounts duringthe month in which the refinancing occurred(GNMA this rnonth, FNMA ~,. this

‘The model in this appendix differs from Duca’s in somerespects, including assuming a more uniform rate of mort-gage closings during each month and that funds remain inliquid deposits somewhat longer during the month follow-ing the refinancing before they are withdrawn by investors.

2The exact monthly scheduled amortization rate is a func-tion of the outstanding balances, rates and terms on themortgages in the pool. Such calculations require extensivedatabases well beyond the scope of this study. An alterna-

tive set of estimates that assumed scheduled monthlyamortization equal to 2 percent of outstanding aggregateprincipal had a relatively large number of months whereinactual principal payments were less than estimated sched-uled payments and, hence, was rejected as implausible.

63

month, FHLMC this — month). Paymentsreceived by servicers early in the month havelarger impacts on month-average deposit levelsthan payments received late in the month.Herein it is assumed that mortgages close at auniform rate during the month. Under this as-

sumption, the weighted average holding periodfor payments received by GNMA and FNMAser\’icers is 0.50 months, i.e., GiMVIA — this

month — ENMA — this month = 0.50. forFHLMC serviccrs, who generally hold unsche-duled principal payments for five days or less,an average holding period of 0.15 months isassumed,

The average number of days, expressed as a pro-portion of the month, that funds due to MRSinvestors are held in liquid deposits during themonth following the refinancing (GNMA last

month, FNMA last — month). UnderGNMA and FNMA servicing rides, unscheduledprincipal payments received by servicers duringthe preceding month are remitted to investorson the 15th and 18th of the current month, te-spectively. Funds may be on deposit longer ifinvestors do not withdraw them immediately.Values of 20 days and 23 days, correspondingto GNMA last — month = 0.67 and FIVIvIAlast month 0.77, are used in the calcula-tions below. These somewhat longer periodswet-c suggested by examination of daily depositdata reported to the Federal Reserve by sever-allarge banks. For FHLMC, this is set equal tozero,

For l”NMA servicers, the proportion of incom-ing funds placed in MMDAs rather than demanddeposits (IVIA’IDA share). A value of 0.25 is as-sumed below,’ Funds in M MUAs are assumed toremain on deposit for the same nutnber of daysas funds placed in demand deposit accounts.

Monthly liquidation of GNMA-guaranteed MBSsequals, by definition, the amount of GNMA-guaranteed MRSs issued during the month minusthe change in the amount of GNMA-guaranteedMBSs outstanding as of the end of each month:

liq (JNMA — iss — AGi\~\4A — sth.

In turn, the amnount of unscheduled principal pay-

amount of GNMA-guaranteed MBSs outstandingat the end of the previous month:

GNMA — on = GNMJI lit; — norm — lit; *

GNMA stk — lag.

Liquidations and unscheduled principal pay-ments for FNMA and FHLMC are calculated inthe same manner.

‘I’he amount of demand deposits that are cus-todial account balances due to GNMA mortgageservicers is calculated as:

VIA — dda = GNMA this — month *Gj\TMA— on + GNMA — last month *GNMA on— lag.

For FNMA servicers, the amount is:

FNMA — dc/a = (1 -MMIJA share) * (FNMA —this — month * FNMA — on + FNMA /ast— month *FNMA tin lag);

and for- FHLMC it is:

FHLMC — dda = FHLMC — this month *

FF-JLMC — on

A similar calculation is made for’ the holdings ofMMDAs by FNMA servicer-s.

An MRS-adjusted, not seasonally adjusted(n.s.a.) demand deposit series is obtained bysubtracting the sum (GNMA — dda + ENMA —

dda + FHLMC — dda) from published n.s.a.monthly levels of demand deposits. The resultingdemand deposit series is seasonally adjusted us-ing the seasonal factors for demand depositspublished by the Federal Reserve Board staff inMoney Stock Revisions (1993). (Seasonal factorsare recovered from the published data by divid-ing the n.s.a. level by the s.a. level.) The differ-ences in growth rates of demand deposits andMI shown in the upper two panels of figure 6are calculated from published and these adjust-ccl data.

An MBS-adjusted, non-MI component of M2 isobtained by subtracting the estimated amountof MRS-related MMDA deposits from the pub-lished, seasonally adjusted. non-MI componentof 212. (Since the non-MI component of M2 isseasonally adjusted by the Federal ReserveBoard staff as a whole, and separate data onMMFJA are not available, the seasonally adjustedseries was adjusted liv MRS effects.) The growthrates shown in the lower panel of figure 6 arecalculated from published M2 and from the sumof the MRS-adjusted Ml and non-Mt compo-nents of M2.

ments received by

month is assumedGNMA-guaranteed

GN MA ser~’icersduring ato equal the liquidations ofMRSs minus 1 percent of the

‘The value of 0.25 is from Duca (1990).