UPDATE 1-Fed's Duke says Fed may hold mortgage-backed bonds longer

Fri Mar 8, 2013 9:45pm EST

* Says housing recovery set to strengthen

* Warns tight credit a headwind, says new rules partly to blame

By Alister Bull

WASHINGTON, March 8 (Reuters) - The U.S. Federal Reserve may consider holding mortgage-backed securities, or MBS, longer on its balance sheet to minimize market disruption instead of selling them as it exits easy monetary policy in the future, a top Fed official said on Friday.

Fed Governor Elizabeth Duke also said the broad recovery in U.S. housing was likely to strengthen as an improving economy unleashed pent-up demand, but she warned that tight credit conditions could be a drag on the upswing.

"The strength of this momentum will be determined by credit availability to these new households, an availability that may be much slower to return as mortgage market participants assess the regulatory, market and economic environment," she said.

Duke reminded a Mortgage Bankers Association conference in Avon, Colorado, that the Fed decided in 2011 it would sell its MBS holdings when it eventually tightens monetary policy.

"We might conclude that sales of MBS in volumes sufficient to meet the parameters of the exit strategy principles might create significant market disruptions," she said.

In that case, said Duke, the Fed might consider "holding the securities for longer or allowing them to roll off more gradually."

It was the latest remark from a Fed official to indicate that the idea of not selling bonds from its balance sheet is under serious consideration and follows comments hinting in a similar direction by Fed Chairman Ben Bernanke last week.

Policymakers can discuss the topic further when they meet on March 19 and 20 for a regular assessment of the U.S. economic outlook and their aggressive actions to boost the economy.

The U.S. central bank is currently buying $40 billion of MBS every month, as well as $45 billion of Treasury bonds, in an aggressive bid to support the U.S. recovery.

It has also held interest rates near zero since late 2008 and vows to keep them there until unemployment hits 6.5 percent, provided inflation stays under 2.5 percent. The U.S. jobless rate fell to 7.7 percent in February from January's 7.9 percent.

Duke said that an improving economy would help housing make further gains, but cautioned that credit conditions could prevent younger people who may have weaker credit scores from buying a house, restraining an important source of demand.

"I expect demand to come from a pickup in new household formation, but I also recognize that these households may be the very population that faces especially tight credit conditions," she said.

Fed research shows that over half of first-time buyers in the early 2000s were people with low or middling credit scores, but many of those people would struggle to get a mortgage in today's market, she said.

Part of the reason lay in the numerous new financial rules proposed since the housing market collapse to prevent a repeat of abusive lending practices that contributed to the subprime mortgage market crisis.

Duke, a former banker, said no one wanted to return to the pre-bubble days, but she listed a range of reasons why some of the proposals would add to the cost of getting a mortgage for borrowers with weaker credit.

"It will be up to policymakers to find the right balance between consumer safety and financial stability, on the one hand, and availability and cost of credit, on the other," she said.

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