Are we getting ready to see a rise in rates in a couple of months? I can't see how they can stay where they are...
The Fed will stop buying mortgages beginning at end of March 2010.
Uh-oh. This is kind of a big deal.
Lets reflect back for a minute…
Back in September 2008 the bottom fell out of the mortgage and housing industry, the pillar of our economy at the time, as the MBS market was more or less exposed as a fraud and subsequently deemed toxic rather than the AAA rated investments they were being pimped out as. Former Wall Street stalwarts like Bear Stearns and Lehman Brothers were heavily invested in such securities and subsequently imploded almost overnight. Banks, lenders and the credit (mortgages) they offered disappeared like a David Blaine magic trick- *poof*
Crisis ensues and the government steps in to cauterize the gaping wound, funding the market to the tune of some trillion or so dollars in lieu of risking a catastrophic ceasing of our (and the worlds) economic engines.
Fast forward to January 2010.
The trillion dollar capital infusion coupled with keeping the overnight funds rate at or near zero has kept interest rates low and market volatility in relative check. Well this is about to change.
First, you can’t print a trillion new dollars and not expect inflation at some point on a relative level. Apart from the inflation dynamic, the Fed has decided that its time to cease backstopping the MBS market, and as a direct result, the housing market…preferring to hand things back off to the private sector.
Wait a minute…What private sector?? Who has an appetite for MBS’s and more importantly at what yields?
You can bet as sure as the sun will rise in the east tomorrow that the private funds, banks, lenders and their managers who do play in this sandbox will buffer margins to mitigate perceived risk in such securities, which all but guarantees higher interest rates.
The remaining banks are well capitalized for the most part (compared to late 2008, early ‘09), though they are still very gun-shy to lend except under the most pristine personal credit and financial conditions. Ask any mortgage originator about perpetually moving underwriting guidelines.
Pundits have warned of a ‘false bottom’ when it comes to the housing market for some time. Feel the floor shaking yet? As interest rates rise, housing affordability decreases subsequently exerting downward pressure on housing values…again.
What happens if the bottom does fall out?
I’m sure President Obama and his staff aren’t keen on sending the economy back into a tailspin. Surely the Fed has thought through the potential ramifications of their pending actions. They could simply step back in at anytime to shore up the market if things got too volatile, using Fannie Mae and Freddie Mac as the primary vehicles to do so…alas there are calls to abolish these GSE’s all together.
As stated, inflation has to be a big concern here too. How does the Fed pull all the ‘new capital’ out of the market to avoid hyper-inflation in a way that doesn’t send the economy back towards a protracted recession? One way is something called a ‘reverse REPO‘, where they sell their stockpile of MBS’s with a guarantee to buy them back in the future at a profit for the purchaser. Seems that this obscure company called ‘Google’ (among others) may be interested in this play…
Interesting times to say the least…the stakes are HUGE and not for the faint of heart.
Originally posted at TheXBroker on 1/27/10