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How the Bond Markets React 04.04.06
Mortgage Backed Securities Stay Hot
One of the biggest concerns about the mortgage markets has been the possibility of a bubble. The problem lies in how you identify it. Is it the hot pricing? Is it the lack of inventory? Is it the fact that everyone is talking about it? Hardly worthy explanations for the shelter turned investment.
I have gone on record repeatedly suggesting that the notion is overblown if not simply non-existent. Yes there is a cooling trend developing. Yes, we will see slow single digit gains in the industry for some years to come. And yes, it will come even as mortgage rates have climbed right along with the Federal Reserve¹s 15 straight interest rate hikes.
If you really want to worry about this portion of the economy, please go right ahead. Until the concern developes in the mortgage backed securities market and to a lesser degree, among the Real Estate Investment Trust or REITs, there is little to be worried about.
For the uninitiated, mortgage backed securities are the life-blood of the lending industry. When a loan is generated, it is usually sold, bundled in a package of securities that are then sold as a fixed income investment. It was generally believed that once the Fed began its campaign to raise rates, banks would be less inclined to generate new loans or shed their long term rates in favor of a short term notes.
The void created by the two largest lenders, Fannie Mae and Freddie Mac following Congressional insistance that these to government-sponsored agencies increase their minimum capital requirements in an effort to keep them from becoming over-extended has left room for banks.
With the two biggest players somewhat sidelined, banks have stepped in and kept this market from faltering for reasons that are fairly straightforward. Banks were able to absorb the less than attractive rates these securities were offering largely because of another ripe source of cashflow, fees from other banking operations such as ATMs. This gave banks an opportunity to jump in a take almost $2 trillion in mortgage bonds that would have been otherwise held by Fannie and Freddie.
The second reason banks have held steady, even increased their exposure is due to the relative weakness in the long term rates offered by the Treasury makes these securities much more attractive. The inverted or flattened yield curve, which continues to play havoc with the Fed¹s data driven decisions, seems to have some staying power. It was Greenspan's conundrum. The new Fed chief, Ben Bernanke has given it only a passing nod although convinced that it means little to the ultimate goal of the central bank.
It is generally assumed that when the short end of the fixed income market offers a higher rate than the long end, a recession can not be far if the offing. While it has yet to happen, those fears remain even as the curve has adjusted slightly positive.
An economic move to the downside might change the Fed¹s thinking and cause a rate reversal which would be good for these mortgage backed securities and would stimulate homeowners to delve into some of the estimated $11 trillion worth of equity as yet untapped.
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