Quantitative Easing and Agency MBS Investment and Financing Choices by Mortgage REITs

Abstract

An emerging literature documents a link between central bank quantitative easing (QE) and financial institution credit risk-taking. This paper tests the complementary hypothesis that QE may also affect financial risk-taking. We study Agency MREITs – levered shadow banks that invest in guaranteed U.S. Agency mortgage-backed securities (MBS) and that are principally funded with repo debt. We first show that Agency MREIT asset growth is inversely related to the Federal Reserve’s Agency MBS purchases, reflecting investor portfolio rebalancing. We then document that Agency MREITs increased financial leverage during the later stages of QE, consistent with “reaching for yield” behavior. However, Agency MREITs countered the heightened solvency risk by extending repo maturity and increased hedging of their funding costs to reduce liquidity and interest rate risk. The findings suggest that research linking QE to increased credit risk-taking should account for contemporaneous changes in financing choices and risk management.