MBS - The Fed (Taxpayer) Has To Bail Out Foreign Central Banks

“….over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.”

I don’t think this recent move has to do as much about lower mortgage rates for you and me rather Foreign Central Banks and the likes of Bill Gross being in a panic over their holdings. Before this announcement in early December, MBS were not performing well with all-time historic wide spreads over longer dated Treasuries.

As a matter of fact, there is a good chance rates do not come down to the levels being forecast. After nearly a month of constant headlines about the Fed buying Agency MBS, a 30-year fixed today is still around 5.25% at 1 point vs 5.75% prior. A few days in the past month we saw sharp dips down under the 5% level, but that market action was fleeting lasting one or two days and rates quickly shot back up.

Foreign Central Banks have been in the US mortgage market for a long time and arguably did not know what a mess the GSEs and their lending practices were. Bill Gross, the largest holder of Agency debt outside of the FCBs, admittedly bought a large portion of his present position front running the Fed knowing full well the risks in owning mortgage-related debt. Until the Fed made its recent announcement, all Agency debt owners were feeling a tremendous amount of pain, as MBS had been kicked to the curb in favor of UST. Wars have been waged for much less than seeding an FCB’s balance sheet with hundreds of billions in toxic securities.

Drastic times call for drastic measures and printing, in order to buy MBS, was a real ‘Hail Mary’ move. But I suppose it had to be done given that at the end of November, the mortgage scene was looking bleak. 10-year Treasures were holding below 4%, the short had been bid to zero and mortgage rates were rising as the government refused (and still does) to issue that illusive ‘explicit’ guaranty. Currently, with the GSE’s in conservatorship Agency MBS have an ‘effective’ guaranty.

It is no doubt that the FCBs, with the global crisis reaching deep into their balance sheets as well, were not too thrilled about owning relatively illiquid GSE mortgage debt without a ‘Full Faith and Credit’ backing. Especially considering how the sector worsens monthly as home prices tumble, defaults surge and the nation is in the midst of one of the nastiest recessions ever. To top it off the solons (ex-Ben) that created all of the ‘plans’ leave office and the fate of the GSEs and the paper they back is anybody’s guess. Adding another $5 trillion in mortgage guarantees on top of the near $9 trillion in existing backing could do some real damage to the US sovereign debt rating.

GSE MBS used to be relatively liquid with predicable durations. But now with values down creating epidemic negative-equity across America, defaults surging and unemployment rising, nobody has any clue how long these loans/MBS will be on balance sheet. Very few home owners keep a loan for 30-years that’s for sure. If they don’t or can’t refi then death, disease, job-loss etc will get them over time. Very few MBS holders likely ever thought they would be in their positions as long as many presently even have. I can promise you that China and Russia do not want to be landlords of a bunch of over-leveraged, unemployed American’s.

Who would want a bunch of Agency MBS after everything that is now known about all of their Alt-A and Subprime holdings, terrible risk management and massive house price depreciation that results in significant losses every time a loan is foreclosed upon? ‘Face value’ surely doesn’t mean what it used to now that the collateral underlying the securities is down 25% to 75% over the past 18-months depending upon where the properties are located. Most Agency MBS in existence today are time bombs.

Foreign Central Banks Pare Agency Debt -Uncertainty May Cloud Fannie, Freddie Note Sales in First Week of New Year - By PRABHA NATARAJAN

In a sign of the uncertainty weighing on mortgage companies Fannie Mae and Freddie Mac, foreign central banks continued to trim holdings of U.S. mortgage-related debt.

This comes as the two nationalized firms, which together account for about half of the $12 trillion U.S. home-loan market, are slated to sell debt issues in the first week of 2009.

Data from the Federal Reserve Bank of New York published Monday show foreign-central-bank holdings of debt related to the mortgage companies, including debt sold by the Federal Home Loan Bank system, stood at about $819 billion on Dec. 24, down from $833 billion on Dec. 17.

Foreign-central-bank holdings of this debt, which includes bonds sold directly by the firms and mortgage-backed securities they guarantee, reached a peak of nearly $986 billion in mid-July, after the Treasury first asked for the authority to extend its credit lines to these firms. Click link above for more…

So, what is the most efficient way to help our FCB buddies sell their trash MBS? Right…get the US taxpayer to buy it. Print money and put a bid under MBS for the next year with announcements and selective buying of $5 billion here and there whenever the market gets weak. Then the FCB’s and Gross can sell into artificial strength and buy US Treasuries with an explicit guaranty.

“Purchases will be financed through the creation of additional bank reserves.”

“The goal of the program is to provide support to mortgage and housing markets and to foster improved conditions in financial markets more generally.”

“The New York Fed will adjust the pace of its purchases based on input from the investment managers about market conditions and the impact of the program. The investment managers will be required to purchase securities frequently and to disclose the Federal Reserve as principal.”

Maybe PIMCO, as one of the four chosen investment manager and largest owners of GSE MBS, can start paying its dividend on all of its funds again soon. If this is not ‘the fox in charge of the hen house’ I do not know what is.

On a higher level, this approach could kill all sorts of birds with one stone unless the parties involved don’t follow through with the Treasury buying plan and decide to sell those into strength too. That could put the US in a position where the Fed is the lender of last resort printing money like crazy to buy everything - that would be bad news…Doh!

If this is indeed the plan, the big question going forward is if the buy pressure from the Fed and all of the lemmings chasing the Fed is enough to offset the sell pressure from the Foreign Central Banks. If buy and sell pressure are about equal, obviously MBS and rates tread water. If not and people smarten up to what is really happening and panic out of MBS, then rates go up quickly. That is of course unless the Fed cranks up the tax payer printing press and buys more they announced, which is a highly probably outcome.

After nearly two-years of misinformation and games why don’t they just be honest this time around…

To ensure the system stays together, wars are not waged and mortgage rates don’t shoot to 20%, the US taxpayer is being called upon to clear the balance sheets of Foreign Central Banks and investors.  These parties which did not understand that there was never an ‘explicit’ guaranty and trusted that what we were selling were not balance sheet nuclear bombs are needed this minute to fund our book.

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