Fed Buying Agency MBS - Still No ‘Explicit’ Guarantee

This one better work guys. I have my doubts.

As you all know, Fannie (FNM)/Freddie (FRE) mortgage-backed securities (MBS) have been under fire for at least a month taking mortgage rates up as everyone was a seller in lieu of US Treasuries.  The spread between MBS and UST has been sitting at record levels. This had gotten to the critical level. Of course, intervention was the only way out so the Fed announced it would buy $500 billion in Agency MBS likely over the next six quarters to ensure mortgage rates stay down. This was a very controversial move that had better work but serious questions remain.

We have seen several attempts to ‘talk the markets better’ and this may be just another one of those. We know that Foreign Central Banks are uncomfortable with their Agency holdings and have been reducing them sharply in recent months.  Without intervention, this likely would have continued and led to a serious trashing taking mortgage rates sky high.  It would have also really pissed off Foreign Central Banks and Bill Gross.

This ‘announcement’ worked immediately and took mortgage rates down more in one hour than at any time I remember.  But as investors thought about this move more clearly and used this ‘announcement’ to sell at better prices, the market leaked. All mortgage lenders were forced to re-price for the worse multiple times yesterday. Rates are still great but nowhere near that initial knee-jerk better off of the news yesterday morning.

But why did they do this?  They could have just said ‘all GSE debt is now ‘explicitly guaranteed’. It would have had the same effect.  Over time it could have had a more lasting effect.  Or would that additional $5 trillion in exposure on top of the near $9 trillion the US has taken on recently have had terrible effects across the curve?

Agency MBS are not ‘explicitly guaranteed’, rather under conservatorship they are ‘effectively guaranteed’, which has scared to death many large investors. MBS spreads over US Treasuries clearly show this.  They likely did not want to make that announcement yesterday taking us to the quantitative easing stage, but they had to.  That’s because they could not ‘explicitly’ guarantee the GSE’s $5 trillion+ in mortgage guarantees.

In my opinion, yesterday’s announcement that over the next six quarters the Fed would buy MBS was an attempt to talk the market better and is proof that they are not planning to explicitly guaranty the debt. If I were a Foreign Central Bank or Bill Gross, I would want an explicit guaranty vs .gov buying a paltry $100 billion in GSE MBS per quarter. Remember, this $500 billion represents only approximately 10% of the total outstanding GSE mortgage guarantees.

I hope I am wrong here, but I see this move as more of a cushion that allows large Agency MBS holders to sell rather than a move to keep mortgage rates down over a long period of time. I bet we see a 6 handle on mortgage rates by year end.

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