Conventional wisdom states that mortgage rates shall increase once the Federal Reserve reteats from its unprecedented move into the market March 31st. However, if this were to be true - you'd think the market would be sniffing it out ahead of time and we'd already see a moderate increase. Instead, long term rates remain fixed near 5%. Aside from the bullish views below, some very smart people are speculating that the Christmas Eve massacre [Jan 5, 2010: WSJ - The Treasury Department's Christmas Eve Masscare of the US Taxpayer] was an under the table way to hand off the responsibility of suppressing mortgages from the Federal Reserve to Fannie & Freddie. (aka FanFredron)
If the left hand or the right hand is buying mortgage backed securities (MBS), it really doesn't matter. Further, if *everyone* believes that if rates jump too high (as judged by a small cadre of people, rather than the market) the Fed will come back to the rescue, it tends to self fulfill. Which in and of itself will help to surpress rates. Showing once again how free markets are nothing more than a cool bumper sticker in the US nowadays.
- Conventional wisdom holds that the end of the Federal Reserve's $1.25 trillion mortgage-buying spree will be catastrophic for housing. But a growing number of investors are betting that the fears are overstated and mortgage rates won't soar when the Fed leaves the market in just over two months.
- Fed officials believe they can pull back successfully. And a growing group of optimists are joining their camp. They argue that investors, searching for higher-yielding securities, will find government-backed mortgage-backed securities a bargain relative to other investments, like corporate debt, that have rallied for much of the past year.
- The optimistic view hinges on the government remaining an enormous presence in the mortgage market, both through its mortgage-backed securities holdings and the widespread expectation that it could jump back in if the market falters. (moral hazard at it's finest - if anything goes wrong, the Uncle Sam shall unfurl his nipple for the speculators to suckle on, yet again)
- Pessimists worry spreads could rise a full percentage point, which could take 30-year conforming mortgage rates to 6% from 5%, a potentially crippling blow to a still-shaky housing market. But spreads mightn't have to widen nearly that much to attract private investors hungry for yield at a time when cash yields nothing.
- So far, the numbers support the optimists. In recent weeks, the Fed has slowed its average weekly net purchases of mortgage-backed securities from $21 billion to about $12 billion. Despite this, the spread between mortgage-backed securities yields and risk-free Treasury yields is thinner than last September, when the Fed said it was extending its mortgage buying program by a quarter. This spread is the basis for the rate people pay when they borrow to buy a home. Any widening typically pushes mortgage rates higher by an equal amount almost immediately.
- Large bond mutual-fund managers, such as Pimco, have dialed back on their mortgage investments in the past year and now may be short of their usual allocations to mortgages by up to $350 billion, estimates Ohmsatya Ravi, head of U.S. securitized products research at Nomura Securities International. Their buying could be enough to replace three or four months' worth of Fed purchases, notes Mr. Ravi, who said he doubts mortgage spreads will widen more than 0.2 percentage point when the Fed stops buying.
Another key point below:
- Meanwhile, the government will remain an enormous presence in the mortgage market even after the Fed stops buying. The Fed will have a $1.25 trillion mortgage-backed securities portfolio after March. Unless the Fed sells its securities, its holdings mean a lot of supply is being held off the market, at a time when new mortgage originations are anemic, keeping prices from falling too far.
Basic supply and demand. If an artifical force (the Fed) comes in and warehouses massive amounts of supply - this keeps prices from falling too low since you relatively consistent demand but far less supply. Economic 101 says prices then must go up over levels that would exist in a market free of interference.
And another way to keep supply off the market -
- Meanwhile, the Treasury Department in December said it would provide unlimited support to Fannie Mae and Freddie Mac and wouldn't require the agencies to reduce their $1.5 trillion mortgage holdings, as previously planned, a show of government commitment that has lifted mortgage prices.
Coming full circle to the which shell is the Mortgage Backed Security under? idea presented in the first paragraph of this piece...
- Some analysts even suggest that Fannie and Freddie, now with greater government backing, could buy more mortgages if spreads widen drastically and the Fed declines to help.