According to this article on CNN Money’s website gas prices are expected to climb back towards the $4/ gallon level. Althugh there is still a lot of uncertainty about the extent of the damage to oil producing infastructure caused by Hurrican Ike it looks like gas prices will be increasing. I’ll be filling up my tank today!
Keep in mind that higher energy prices can add inflationary pressure on the economy which is bad fro mortgage rates.
Unless you live in a cave you are probably very familiar with the fact that the federal government recently announced that they would assume control of mortgage industry behemoths Fannie Mae & Freddie Mac. The move has created overwhelming media coverage and speculation with mixed messages on the potential outcomes.
However, very little of the media’s coverage has focused its message on educating the reader on why these two entities are so crucial to the US economy and what practical implications the move will have on the general public.
For more information on why these two institutions play such an important role in our economy please visit this link which I wrote back on July 15th.
The bottom line is that government intervention of this magnitude into the financial markets is unprecedented and therefore accurately predicting the potential ramifications is next to impossible. However, there are 4 main points which I think the general public should be aware of.
→ Mortgage Rates: By stepping in and assuming the guarantees and obligations of Fannie Mae & Freddie Mac the federal government has provided additional confidence into the mortgage-backed bonds which ultimately determine mortgage rates. Furthermore, as a part of the plan the federal government announced that they would invest $5 billion into the mortgage-backed bond market.
These two measures have caused mortgage rates to drop and some analysts believe that mortgage rates will continue to drop into the near future (For a more detailed explanation of this impact please visit my blog posting on September 8, 2008 @ http://www.swansonhomeloans.com/?p=698).
→ Future Underwriting Standards: What is not commonly understood by the general public is that Fannie Mae & Freddie Mac ultimately set or heavily influence the guidelines to determine what loans will be approved and not approved for virtually all loans in the mortgage industry.
Some have speculated that the federal government may begin to loosen underwriting standards in the near term to help prop up the housing market. However, in the long-term underwriting standards may become influenced by who sits in the oval office & Capitol Hill.
→ Loan modifications: For those who find themselves in trouble with their existing mortgages this move may prove to make a loan modification easier to negotiate. This is because most analysts agree that the government will be more willing to work with troubled homeowners than public corporations who have to answer to stockholders.
→ Future taxes/ inflation: Unfortunately whether you do or don’t stand to benefit from any of the previous three points everyone you will get stuck with the bill in the form of higher taxes and/ or higher inflation.
By assuming control of Fannie Mae & Freddie Mac the government is now guaranteeing the interest payments on the $5 trillion that each of these entities has in their combined loan portfolios. If 5% of these loans go bad then the US taxpayers are on the hook for $250 billion. Although it should be noted that the alternative of not bailing these institutions would likely cost our economy a lot more in terms of financial disaster.
The bottom line is that the government takeover of Fannie Mae & Freddie Mac will impact different people in different ways. For now the only sure thing is that mortgage rates have dipped lower on the news. If you’d like to discuss how this could impact your individual situation we’re always happy to review it with you. Please call or email us!
If you found this posting informative and useful please feel free to leave a comment below and pass it along to others who can enjoy it!
Mortgage rates are up across the board today. We shifted our outlook to a locking position on Friday and our shift proved timely.
We alluded to technical trading patterns on Friday as a reason to lock and mortgage-backed bonds have now broken below the 100-day moving average which is partially why rates have moved higher.
Watch today’s you tube video to understand why we think lower oil prices will initially cause rates to rise but then move back lower.
Current Outlook: locking in near term but recommending a long-term floating stance
In his speech to the worlds most powerful central bankers today Fed Chairman Ben Bernanke spoke briefly about inflation according to this NY Times article.
From the article, “Mr. Bernanke, while acknowledging ‘an increase in inflationary pressure,’ reasserted his view that in the near future, the upswing in inflation from the oil and food shocks was likely to moderate.”
If his outlook proves correct this would be a good sign for mortgage rates. Mortgage rates have ticked higher over the past few months in response to higher inflationary pressures (i.e. commodity &/ energy prices). If these pressures to moderate then hopefully mortgage rates will also move lower.
I often reference “mortgage-backed bonds” (AKA MBS’s) in my daily rate updates. If you follow rate update consistently then you know that when MBS prices fall interest rates rise and vice versa.
The WSJ published a story today regarding investor confidence in high-quality MBS’s and how they remain attractive for bond investor guru Bill Gross & PIMCO.
Here are a few good takeaways and what it may mean for interest rates in the near term:
* “Freddie’s mortgage bonds were trading at a risk premium of around 2.64 percentage points over the 10-year Treasury note’s yield, which was quoted late Thursday at 3.837%.” -A ‘risk premium’ is the spread that an investment earns above and beyond the 10-year US Treasury note (considered to be an extremely safe investment). The idea is that the larger the spread the more risky the market perceives that investment. The current spread between MBS’s & 10-year Treasury notes is relatively high compared to historical standards. The good news is that in all likelihood we will see the spreads shrink in the future which means mortgage rates will have to come down or Treasury yields will have to move higher (or some combination of the two).
* “Even though Congress passed legislation last month allowing the Treasury Department to provide liquidity to Fannie and Freddie, the Treasury has stopped short of announcing any immediate bailout plans. The uncertainty about the government’s plans have fueled sharp price swings in the companies’ stocks, bonds and mortgage bonds” -This helps to explain why mortgage rates have been as volatile as they have been over the past couple weeks. This will likely persist for a few months.
* “Fannie and Freddie guarantee or own nearly half of the total $12 trillion U.S. mortgages outstanding. They have long been the mortgage-bond market’s backstop, stepping in to buy when other investors have failed to materialize. With their finances under pressure, however — both companies have reported losses as the housing market has weakened sharply — they have been curtailing their mortgage purchases.” -This is not terribly encouraging. The housing market needs the two GSE’s to stabilize the secondary market for mortgages.
Rates are modestly lower this morning.
Renewed credit worries have helped mortgage rates remain low in the face of hot inflation data. Here are links to the articles that were referenced in today’s rate update video:
Although inflation expectations are the primary factor that influence the direction of mortgage rates on a day-to-day basis the stock market can also have an impact.
To understand how this relationship works it’s first important to understand how mortgage rates are determined.
Mortgage rates are entirely determined by the price of mortgage-backed bonds (MBS’s). MBS’s are bonds that are issued by Fannie Mae and Freddie Mac that are backed by the interest paid by mortgage holders. Like the stock market, there is an exchange where MBS’s are traded.
There is an inverse relationship between the price of MBS’s and mortgage rates. When the price of MBS’s increase mortgage rates drop and vice versa.
So, to understand how the stock market can influence mortgage rates we have to understand how they impact the price of bonds. Stocks and bonds compete for the same investment dollar.
In other words, an investor with money to invest has to make a decision to invest their money in either the stock market or in the bond market (it should be noted that there are other investment options, but these two classes are the primary vehicles for investment capital).
For an investor, stocks are generally thought to provide higher returns over time but also come with greater volatility.
Conversely, bonds tend to have lower returns over time but have less volatility. Because bonds tend to provide low volatility with modest returns, the bond market can often act as a “safe-haven” for investors who sell their stock positions.
Therefore, in general, when the stock market goes down it is a sign that investors are selling stocks and shifting their capital into bonds. This boosts bond prices and drives mortgage rates down.
Conversely, when the stock market rallies it is a sign that investors are selling bond positions in order to shift capital into the stock market. The greater supply of bonds on the market drives prices lower and pushes mortgage rates higher.
It’s important to understand that there are a myriad of factors that impact mortgage rates on a day-to-day basis.
Inflation expectations and technical trading patterns are two of the primary factors that we monitor. However, in the absence of new information on these two topics it’s not uncommon for mortgage rates to be impacted by the stock market in the aforementioned manner.
I got this email from an industry insider today. Although the email string doesn’t indicate who wrote the email apparently it is from a Fannie Mae official who tracks the investment communities’ demand for mortgage-backed bonds. Why is this important? This email explains in detail who the typical buyers are for mortgage-backed bonds and why they aren’t buying right now. The lack of demand is ultimately the factor which is driving mortgage rates higher.
Here’s a copy of the email-
These are Fnma’s comments on the selloff in MBS…
Bit long but addresses the questions:
1. Why aren’t mortgage rates better (i.e. why is the spread between treasuries and MBS the greatest since 1986)?
2. Why is FHA pricing so good?
3. What is likely to happen with jumbo pricing in the near term?
4. Why are arm rates so volatile right now?
Many of our client’s will appreciate this info….
The Capital Markets Sales Desk has fielded a large number of calls from customers simply asking, what’s going on? Why is the mortgage market trading lower every day? The following are reasons that could help explain why mortgages are struggling and why current market conditions are so volatile. The question is, why are mortgages widening or losing value vs other benchmarks like treasuries? Mortgages are widening for a number of reasons. First, there are no buyers. The dealer community is quite full and has no more balance sheet to hold mortgages. In addition, with the market so volatile, dealers don’t want to own mortgages at this time. Another reason why dealers do not have an appetite for risk is quarter end. Most dealers are experiencing a quarter end in March and have become even more conservative. Banks are not buying either. They are more concerned with retaining capital to cover potential losses in other sectors. Banks and other securities firms have written down an astonishing amount of losses since the subprime mortgage market fell apart last summer. According to Bloomberg, as of February 8th, write-downs by banks and securities firms around the world had reached $120 billion. Therefore, banks remain defensive and prefer to either retain capital or put it to work in other AAA rated sectors. Asia has been noticeably absent as well. Asian banks generally buy on strength and its obvious there hasn’t been any strength exhibited in the mortgage market recently. Also, Asia is generally more active at the end of the month so their absence this week is not a complete surprise.
Money managers and hedge funds aren’t buying for the long term either. What they are doing is called momentum trading. They are buying at the wides (cheap) and selling at the tights (less cheap). Since they are buying and selling, they are not taking any production out of the market leaving the market to trade in a volatile fashion. The market is also trading very thin so exaggerated price movements occur when larger blocks are brought to market. Okay, we know that dealers, domestic banks, Asia, money managers and hedge funds are not buying. But, who is selling? Well, we know servicers have been selling. When the market sells off, the current coupon increases and servicers attempt to keep their hedges in the current coupon. Therefore, servicers need to sell lower coupons (longer duration coupons) and purchase higher coupons (shorter duration coupons). This is called moving up in coupon and is a form of shedding duration. However, in large market moves, servicers may need to sell without the corresponding purchase of the higher coupon. This is called outright selling. The outright selling and duration shedding from servicers has put extra downward pressure on mortgages. Originators are also selling. Although, with higher mortgage rates, originators aren’t selling as much as they were a month ago, the amount they are selling remains significant.
Okay, servicers and originators were the two expected suspects, but are there any other sellers? Unfortunately there are, and this group of sellers is what brings fears to the market. Thornburg Mortgage, a mortgage REIT that specializes in Jumbo and Super Jumbo mortgages received a margin call from JP Morgan in late February. A margin call is a demand for cash on an under-collateralized loan. Thornburg was unable to meet a $28 million margin call and may be forced to liquidate its holdings. We are hearing talk of a $4.4 bln list of Non-Agency ARMs and pass-throughs out for the bid from Thornburg today. Another seller may be Carlyle Capital Corp, which is an investment bond fund located in Guernsey, UK. CCC missed four of seven margin calls totaling $37mln and another margin call notice is expected. According to Bloomberg, the fund raised $300mln in July and levered the money to purchase approximately $22bln in various forms of MBS. A portion of this $22bln is expected to be sold, and some market participants venture that a portion is being marketed today.
Although this is only two of the many accounts that participate in the MBS markets, their forced sales could have major repercussions. For example, let’s say the bonds that are sold are sold at very low dollar prices. That may cause other market participants to mark their own portfolio down to current market levels. This may cause further write downs. The fear of further write-downs has banks on the defensive to a point where they want to preserve capital. If banks are preserving capital, then they are obviously not investing in MBS.
The few investors who do have available capital are putting their money to work in more profitable sectors. Municipal Bonds and certain classes of CMBS are yielding more than Agency MBS and have a AAA rating. Despite the inherent “cheapness” in the mortgage market, there are still other safe investment options that are more preferable at the moment.
In summation, we have more sellers than buyers. The selling bias puts pressure on mortgages, forcing mortgage prices lower and wider. The usual buyers of mortgages aren’t buying or are buying other investments at cheaper prices.
Another trend we’ve noticed is a flight to quality within the mortgage market. Generally, when the market experiences a flight to quality, money is moving into US Treasuries. However, with treasury yields so low, market participants are buying the next best thing, GNMA MBS. GNMA MBS has the explicit guarantee of the US Government. Purchasing GNMAs allows an investor to enjoy the explicit guarantee while yielding considerably more than US Treasuries. In times like these, banks prefer to own GNMA MBS vs conventional MBS for a reason other than the explicit government guarantee. The reason is capital. Banks have to hold a certain amount of capital against their investments. However, they are required to hold significantly less capital against their GNMA holdings vs. their conventional MBS holdings. With the flight to quality within the mortgage market, and a preference by banks for GNMA MBS, it is no wonder why the GN/FN swap spreads have gapped out to astonishing levels. The current GN/FN 5.5% swap has gapped out from 18/32s from January 22nd, to its current level of 59/32s. Another thing to keep an eye on is ARM issuance. The yield curve has steepened in recent weeks (current difference in yield between the 2yr treasury and 10yr treasury is 208 bps). Generally, when the curve steepens, the difference in ARM rates and 30yr mortgage rates increases. Therefore, one may assume ARM issuance is likely to increase now that the curve has steepened. However, due to the lack of liquidity in the market, ARM MBS is trading extremely cheap. In other words, the correlation between a steep yield curve and lower ARM rates has decreased. Because lenders can’t sell their current ARM production in the secondary market at respectable levels, they can’t lower their offered rates. When liquidity improves, look for ARM issuance to increase.
This is an excellent explanation of what a margin call is and why it caused rates to rise yesterday written by Barry Habib, CEO of Mortgage Market Guide:
So what happened yesterday? As we all know – only fools think that mortgage rates are based on the 10-year Note – many of them in the media. Yesterday’s action simply underscores this fact. History shows us that Mortgage Bonds and the 10-year Treasury Note are only an exact match 1 trading day out of 100. So, watching the 10-year Note for mortgage pricing is the equivalent of using a broken watch to time your appointment.
Yesterday, losses from The Carlyle Capital Group and Thornburg Mortgage decreased their capital to the point where their financial backers had asked for cash back in the way of a “margin call”. What does this mean? Imagine a home that received a loan with a 50% LTV…but a provision in the loan stated that under no circumstances could the equity fall below 50%. And the home would need to be appraised every day to evaluate this. If that home lost significant value, the lender would be entitled to an immediate repayment. And when the home actually decreased in value, the lender would make a call for capital to make sure their margin of LTV was intact…a margin call. If the homeowner had the cash to meet this call – all is fine. But if the homeowner did not have the cash, the only way to satisfy the lender would be a sale of the home. And that is what Carlyle Capital Group and Thornburg Mortgage had to do yesterday…they didn’t have enough cash to meet their margin call, so they were forced to sell mortgage loans that they were holding. This flood of mortgage paper on the market, pushed Mortgage Bond prices lower…much lower. But this didn’t have any impact on Treasuries, which were in fact higher on the day. As we have always said, these two securities trade independently.