Fannie/Freddie Picking Up Where Fed Left Offby Tim Manni
When we write our Two Month Forecast for Mortgage Rates, we examine the existing factors as well as the pending changes in the markets that will potentially influence the direction of mortgage rates in the near future.
For the last 17 months or so, the Federal Reserve has been the main force behind keeping Conforming mortgage rates at near-historical lows. The Fed’s exit from the marketplace has provided ample fodder on this blog as we strive to anticipate just how their exit will impact the direction of mortgage rates, and who, if anyone will pick up where they left off.
With the Fed’s exit cemented for March 31, we now know for sure that there is another entity (or shall we say entities) in place to keep mortgage rates from increasing by as much as we first thought at the end of last year.
Fannie Mae and Freddie Mac have released their timeline for their “bad loan” buy back program. The two GSEs will pick up where the Fed left off, begining their buy backs in April, immediately after the Fed program ends.
From National Mortgage News:
Fannie Mae on Friday clarified its timeline for its massive buyouts of seriously delinquent loans that reside in agency MBS, confirming that 220,000 notes will be bought in April alone. The April buyouts (for loans 120 days or more past due) affect MBS with coupons of 6.5% or higher. In May lower yielding coupons (6% yield) will be targeted followed by 5.5s and 5s. This is largely in line with expectations that Fannie would buy out the loans by coupon, starting with the highest yielding securities. Fannie’s clarification was designed to calm the market but could prove jarring to investors pursuing MBS-related swap strategies that had been based on the relative uncertainty of Fannie buyouts (in relation to Freddie Mac buyouts). In the wake of the clarification, market participants should short these strategies, according to a Barclays report.
What Does This Mean?
These “buyouts” seem to be another strategy employed by Washington to keep mortgage rates low in the present market.
As a result of all of this, we think that the transition away from a Fed-dominated mortgage market will be smoother than we expected way back at the end of last year when we wrote the last forecast and put the finishing touches on our 2010 Outlook.
How Does This Process Work Exactly?
Since last December, several new developments at Fannie Mae and Freddie Mac will allow them to influence mortgage rates much more than they have in the past. Back on Christmas Eve, the president announced that the GSEs will have an unlimited line of fiscal support. This means that Fannie and Freddie can expand their portfolios immensely, and that any losses sustained by doing so will be covered (by you the taxpayer of course). The expansion of their portfolio holdings and newly available cash resulted in a program announced in mid-February where Fannie and Freddie will “buy back” up to $200 billion in delinquent loans from investors.
The combination of these events means several things. First, the process of sponging up excess supply of mortgage-backed securities (MBS) — done by the Fed for the last 17 months — will be likely replaced by a process which instead limits how quickly securities come to the market, providing a different (though effectively equivalent) sponge.
As such, rather than the process of lenders originating loans, then selling them to Fannie and Freddie — which in turn sold them to the Federal Reserve (and any other takers, of course) — this new arrangement means that Fannie and Freddie can accumulate loans or mortgage-backed securities on their books without needing to dump them into the market all at once; instead, they can slowly release their supply to the market, providing a stabilizing effect on interest rates.
At the same time, the re-purchase of up to $200B of bad loans from investors should produce some gaping holes in investor portfolios, which will need to be refilled. Fixed-income investors may have only a few choices of where to invest funds, with MBS among them. Faced with a handful of cash, it’s reasonable to expect that at least some of the funds will buy new MBS from Fannie and Freddie. The repurchase program will spark fresh private demand for securities, which also serves to keep rates low. Then collectively, the portfolio expansion, meting of new MBS into the market and a mechanism to promote private demand for MBS should help to offset the loss of the Fed’s influence in the market.
Where Do We Go from Here?
Keeping mortgage rates low is a key issue for the housing market. If the above-mentioned happens without incident, we should have a Fed-to-private-market handoff with much less disruption for mortgage rates.