<5% Rates Were So Last Month

We all knew it was coming. Mortgage rates could only stay so low for so long. So why is it such a shock that they've jumped up nearly 1% in just two weeks?

Whenever rates increase 1% in such a short period of time it tends to make people scratch their heads (or bang them on the wall - take your pick). Back before the week of March 25 the 30yr fixed rate was ~4.5%. Now, at the beginning of the week of June 8, the 30yr fixed is ~5.5%.

Although there is no natural law that states, "what goes down must go up," the rate move was a sure thing.

What has caught many off guard is that they spiked so quickly and before many were expecting it. We were getting so used to sub 5% rates that we just assumed they would be around for a while (with the FED in such control and all!). But now we've learned a valuable lesson all over again - take it when you can get it.

So for now, 5.5% is the new 4.5%.

Articles that explain the situation much better than I can:

Bond-market rout lifts mortgage cost (AP, 06/06/09)

Bernanke Conundrum Threatens Housing On Mortgage Rate (Bloomberg, 06/08/09)

WSJ: "Fed Open to Buying More Securities"

As reported in the Wall Street Journal today, apparently there's talk among some members of the Fed's FOMC regarding the idea of purchasing more Treasury bonds and Mortgage Backed Securities (MBS). In other words, they want to see low rates for a longer period of time.

Some Federal Reserve officials are open to raising the amounts of mortgage and Treasury securities purchase programs beyond the $1.75 trillion that they have already committed to buying, according to minutes from the Fed’s April meeting.

“Some members noted that a further increase in the total amount of purchases might well be warranted at some point to spur a more rapid pace of recovery,” according to the minutes of the April 28-29 meeting, released Wednesday with the usual lag. (Read the full minutes.)

The Fed can achieve low mortgage rates by increasing its purchases of MBS - when prices rise, yields (rates) fall. But it takes money, and lots of it. So the longer rates are artificially kept low, the larger the Fed's tab grows.

Thetruthaboutmortgage.com adds a perspective to the issue with it's most recent post about the Fed's slowing MBS purchases:

In a bid to keep interest rates on mortgages lower for a longer period of the time, the Fed has apparently decided to slow its purchase of mortgage bonds, according to a research note from Credit Suisse.

The analysts said they believe Fed involvement in the mortgage-backed securities market will be necessary well into 2010, and as a result, they’ll need to slow buying so it there’s enough purchasing power to remain engaged next year.

As the government reduces its purchases of MBS (and assuming investor demand stays the same), MBS prices will drop and mortgage rates will go up.

So are these two actions incompatible - slowing down purchases of MBS but increasing purchase funding? Not necessarily, because Fed could do both at the same time, all in an attempt to keep the low rate train rolling on.

Geitner on Meet The Press 3/29/2009

I was impressed with how FED Chairman Geitner handled the questions from David Gregory on Meet The Press Sunday morning. Judge for yourself.

Geitner on the importance of bank lending:

Visit msnbc.com for Breaking News, World News, and News about the Economy

Geitner explains banking plan:

Visit msnbc.com for Breaking News, World News, and News about the Economy

Geitner reacts to Krugman's critiques:

Visit msnbc.com for Breaking News, World News, and News about the Economy

David Gregory: "The rules of this program will not change?"
Tim Geitner: "No, they cannot change."

We'll see if Congress complies.

Fed Continues MBS Buy

The Federal Reserve Bank of New York continues to make large buys of mortgage-backed-securities.  For the week ending Wednesday (March 25), the Feds purchased $47.3 billion from government-sponsored entities. 

To date, the Feds have taken on $341.55 billion in MBS.  

More at the Housing Wire

MBS Tally 70 Billion So Far

Broker Universe reports that the Feds have so far purchased $70 billion in GSE (government sponsored enterprise) mortgage-backed securities.  It's part of what might be upwards of $500 billion spent in this way to help push down rates and, thus, help stabilize the housing market.  

The Fed purchases began in early January.  And they've had some success.  From the article:

"The Fed succeeded in narrowing the spread between the 10-year Treasury rate and mortgage rates, according to Mahesh Swaminathan, a Credit Suisse mortgage strategist. "The Fed's buying of mortgages is definitely a positive on the whole, but it doesn't guarantee lower mortgage rates if Treasury rates continue to sell off," he said."

FED: MBS Purchase Program To Begin In January

Release Date: December 30, 2008

For immediate release

The Federal Reserve on Tuesday announced that it expects to begin operations in early January under the previously announced program to purchase mortgage-backed securities (MBS) and that it has selected private investment managers to act as its agents in implementing the program.

Under the MBS purchase program, the Federal Reserve will purchase MBS backed by Fannie Mae, Freddie Mac, and Ginnie Mae; the program is being established to support the mortgage and housing markets and to foster improved conditions in financial markets more generally.

Further information regarding the structure and operation of the MBS purchase program is provided in the attached set of Frequently Asked Questions (FAQs).

Frequently asked questions

Effective December 30, 2008

General

What is the policy objective of the Federal Reserve’s program to purchase agency mortgage-backed securities?
The goal of the program is to provide support to mortgage and housing markets and to foster improved conditions in financial markets more generally.

Why is it necessary for the Federal Reserve to transact in the agency MBS market via external investment managers?
The operational and financial characteristics of MBS purchases are significantly more complicated than those associated with the assets that have traditionally been purchased by the Federal Reserve. The Federal Reserve has chosen external investment managers as a means of implementing the MBS program quickly and efficiently while at the same time minimizing operational and financial risks.

Because of the size and complexity of the agency MBS program, a competitive request for proposal (RFP) process was employed to select four investment managers and a custodian. The investment managers are BlackRock Inc., Goldman Sachs Asset Management, PIMCO and Wellington Management Company, LLP. The selection criteria were based on the institution’s operational capacity, size, overall experience in the MBS market and a competitive fee structure. The contract for a custodian is not yet final.

What securities are eligible for purchase under the program?
Only fixed-rate agency MBS securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae are eligible assets for the program. The program includes, but is not limited to, 30-year, 20-year and 15-year securities of these issuers. The program does not include CMOs, REMICs, Trust IOs/Trust POs and other mortgage derivatives or cash equivalents. Eligible assets may be purchased or sold in specified pools, in “to be announced” (TBA) transactions, and in the dollar roll market.

What is the investment strategy that will be employed?
Investment managers will employ a passive buy and hold investment strategy in accordance with investment guidelines prescribed by the Federal Reserve. Purchases will be guided by commonly referenced market indices. The agency MBS program will involve the outright purchase of up to $500 billion in agency MBS by the investment managers on behalf of the Federal Reserve by the end of the second quarter of 2009. The New York Fed will adjust the pace of its purchases based on input from the investment managers about market conditions and the impact of the program. The investment managers will be required to purchase securities frequently and to disclose the Federal Reserve as principal.

The investment strategy may involve the use of dollar rolls as a supplemental tool to smooth market supply and demand. A dollar roll is a transaction involving the sale of agency MBS for delivery in the current month and the simultaneous agreement to repurchase substantially similar (although not the same) securities on a specified future date.

Does the agency MBS program expose the Federal Reserve to increased risk of losses?
Assets purchased under this program are fully guaranteed as to principal and interest by Fannie Mae, Freddie Mac, and Ginnie Mae, so the Federal Reserve's exposure to the credit risk of the underlying mortgages is minimal. The market valuation of agency MBS can fluctuate over time based on the interest rate environment; however, the Federal Reserve's exposure to interest rate risk is mitigated by the conservative, buy and hold investment strategy of the agency MBS purchase program.

When will the purchases begin?
Purchases are expected to begin in early January, 2009.

Who will the investment managers trade with and who is eligible to sell agency MBS to the Federal Reserve under the program?
Initially, the investment managers will trade only with primary dealers who are eligible to transact directly with the Federal Reserve Bank of New York. Primary dealers are encouraged to submit offers for themselves and for their customers.

Will the agency MBS held by the Federal Reserve through this program be eligible for lending through the Treasury Securities Lending Facility (TSLF) or the daily System Open Market Account (SOMA) securities lending operations conducted by the New York Fed?
There are no plans for the agency MBS held by the SOMA to be available for borrowing through the TSLF or the daily securities lending program.

How will purchases under the agency MBS program be financed?
Purchases will be financed through the creation of additional bank reserves.

What is the legal basis for the agency MBS purchase program?
Purchases of agency MBS in the open market, under the direction of the FOMC, are permitted under section 14(b) of the Federal Reserve Act.

How is the Federal Reserve’s agency MBS purchase program related to the U.S. Treasury’s efforts to purchase agency MBS?
The Federal Reserve’s agency MBS program is separate and distinct from the U.S. Treasury’s program but both programs are aimed at fostering improved conditions in mortgage markets.

How will holdings under the agency MBS program be reported?
Balance sheet items related to the agency MBS purchase program will be reported after settlement occurs on the H.4.1. statistical release titled “Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks.” There will be an explanatory cover note on the release when the new items appear for the first time. However, these data may be published well after trade execution due to agency MBS settlement conventions. In addition, the New York Fed will publish the SOMA agency MBS activity in more detail on its external website on a weekly basis.

What measures will the Federal Reserve take to ensure that an investment manager implementing the MBS program will not have an unfair advantage relative to other market participants due to the information it receives about the MBS program?
Each investment manager will be required to implement ethical walls that appropriately segregate the investment management team that implements the Federal Reserve’s agency MBS program from other advisory and proprietary trading activities of the firm. The New York Fed will monitor each investment manager’s compliance with this requirement.

Where should questions regarding the MBS purchase program be directed?
Questions regarding the MBS program should be directed to the New York Fed’s Public Affairs department: 212-720-6130.

Find the press release here.

A Perspective Behind The FED's Plan To Lower Mortgage Rates, aka The MBS Bailout

In his most recent post, Brad Setser doesn't specifically address the FED's recent action in the Agency MBS market (remember the FED's $500b MBS purchase program?), but he does provide some great analysis of the numbers that are behind the FED's move.

From one of my new favorites, Brad's Follow The Money blog:

This is what a crisis looks like in the balance of payments data, 12/15/08

[Agency - Fannie, Freddie, Ginnie Mae]

"So much for talk that central banks are always a stabilizing presence the market. They clearly have destabilized the Agency market. The fall in demand for Agencies over the past three months — and most Agency demand has come from central banks until recently — has been sharper than than the fall in demand for US corporate bonds (think securitized subprime mortgages, the category “corporate bonds” in the BoP data includes asset-backed securities) after the crisis of last August."

"The Agency market is a rather important market. Increased lending by the Agencies offset the fall in demand for “private” mortgage-backed securities after the crisis last August. More recently, the absence of a “central bank bid” has kept
Agency spreads wide even after the US Treasury bailout of Freddie and Fannie. And that in turn has pushed the US to adopt other measures to bring down long-term mortgage rates. The Fed and the Treasury are literally now buying the Agencies that foreign central banks are selling. Action, reaction …"

Earlier in the same post, Brad points out "[foreign investors added] $400 billion in demand for safe dollar denominated assets [T-bills, T-bonds]. If that kind of monthly inflow is annualized it is a shockingly large number. It allowed foreigners to reduce their holdings of Agencies by close to $75 billion (including a $25 billion fall in short-term Agencies), their holdings of long-term corporate bonds by $13 billion and their holdings of US equities by $6 billion without causing any strain on the dollar."

According to Brad, that's $75b just in October. I'm sure numbers like these make the FED and Treasury nervous.

MBS Market Rallies, Mortgage Rates Set To Improve

10:20am



I guess this is what happens when the Federal Reserve announces a plan to purchase $500b MBS from Fannie Mae and Freddie Mac. Here's today's Bloomberg article about the plan.

And here's the Treasury's announcement to purchase $200b in additional asset backed securities.

Looks like the Administration is directly targeting mortgage rates.

I expect rates to be ~.25% better this morning, and wouldn't be surprised to see the 30yr fixed in the low to mid 5% range this week.


FNMA 30yr 5.5 coupon
up 130bps at 10:15am

The FED's recent open market operations - The Alternative Bailout

This morning the Federal Funds rate was 7%. Doesn't sound so bad, huh? Well, the problem is that the Fed Funds target is 2%. What does this mean? The cost of US banks lending to each other was 5% higher than it should be. If the spread between the actual and target rates persists, banks become very reluctant to lend to each other and to consumers. Draw this out over weeks and the flow of money (lending) will be hindered and the economy will slow down considerably (more than we want).

But the Fed has not been sitting idly by. In order to reduce the Fed Funds spread, the Fed pumped $20b into the money markets at 9:40am today. In fact, over the last 30 days, the Fed has injected $530b into the US financial system. And the problem isn't just with US banks. We are in the middle of a worsening global credit crunch, with one of the indicators being the TED spread (a measure of illiquidity).

The open market operations in which the Fed is engaging is the ongoing bailout, or aka The Alternative Bailout. Granted, we're not talking about a $700b blank check. But the Fed's operations are just as risky, if not more. The assets that the Fed purchases ARE returned to the owner and the loan IS repaid with interest to the Fed, but repayment in the current market is not a given. The assets that the Fed is now purchasing, thanks to temporary policy changes announced on 9/14, are not just Treasuries and MBS (allowed in 2007) but a broad range of asset types such as equities, junk bonds and subprime mortgage bonds.

Fed takes fresh steps to battle credit crisis (AP, 09/29/2008)
"Under one new step, the Fed will boost the amount of 84-day cash loans available to U.S. banks. The Fed is increasing the amount to $75 billion, up from the current $25 billion starting on Oct. 6. Banks bid on a slice of the loans at an auction. That move will triple the supply of 84-day loans to $225 billion, from $75 billion, the Fed said. Meanwhile, the Fed will continue to make $75 billion worth of shorter, 28-day loans available to banks. All told, the total amount of cash loans — 84-day and 28-day — available to banks will double to $300 billion from $150 billion, the Fed said. Moreover, the Fed will make a total of $620 billion available to other central banks, expanding ongoing currency "swap" arrangements with them where dollars are traded for their currencies. That's up from $290 billion previously in such arrangements."

The Fed's balance sheet is $800b, which leaves approx. $200b in lending ability. This is not a good debt-to-high credit limit ratio.

I don't think we have much leftover for Hedge Funds.