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Suresh · Joined: 16 Sep 2005 Posts: 8391 Location: Maryland

If Fannie Mae and Freddie Mac are serious about not re-entering the mortgage-backed security buying business, then when the Federal Reserve ends its quantitative easing program of buying mortgage-backed securities with currency created out of thin air, there will be few if any buyers of any size buying mortgage-backed securities. The lack of a securitization market for mortgages means that banks will be forced to keep more and more of their mortgages. If they must keep the mortgages they've made, then the quality and value of the mortgages must improve to avoid losses and fewer mortgages can be made because the bank has less capital available for deployment. For the quality and value of mortgages to improve, lending standards must increase and rates must increase.

Consider where this is headed. As lending standards and mortgage rates increase, the purchasing power of new home buyers and trade-up buyers goes through the floor. Home values similarly fall through the floor. More homeowners get underwater or go deeper underwater, in which case they start considering jingle mail or squatting.

Anyone here think that the Federal Reserve and/or the government-owned Fannie and Freddie will allow the housing market to tank? Of course, not. At the very least, the Federal Reserve will re-instate its MBS purchase program.
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FT Alphaville: Filling the central bank void
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FT Alphaville has worried before about what might happen once the Federal Reserve ends its $1.25 trillion buying-spree of mortgage-backed securities (MBS). The central bank is due to stop buying MBS in March, when it ends its quantitative easing (QE) is scheduled to end.

Marc Ostwald, of Monument Securities, picks up the thread in a late Wednesday note.
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The first chart shows what Ostwald calls “the artificially low level” of spreads between US 30-year mortgage rates and US 30-year Treasuries. This is the effect of QE and those MBS-purchases, which you can see in the second chart.

But even as the central bank tapers off its MBS-purchasing, it’s still snapping up about $12 billion a month; which suggests that when it finally does end its buying-spree, the exit might come as a shock.

The third chart is the really important one. As Ostwald puts it:

Suresh · Joined: 16 Sep 2005 Posts: 8391 Location: Maryland

Through its mortgage-backed securities buying program, the Federal Reserve enabled Fannie Mae and Freddie Mac to assume the mortgage market. The mortgage-backed securities buying program is scheduled to end in March. The monetary and fiscal policy makers are scrambling now to find buyers for mortgage-backed securities for two reasons. First, if there are scant buyers, the housing market takes another cliff dive. Second, if there are scant buyers, mortgage rates will go up, driving down the values of mortgage-backed securities on the balance sheet of the Federal Reserve.
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Washington Post: U.S. looks to reluctant foreign investors to help fund the housing market
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The Federal Reserve is scheduled at the end of March to halt its purchases of mortgage-backed securities, a move that could drive up the low interest rates that have helped the housing market show new signs of life. The Fed is gambling that private investors will step in to buy the securities, helping to keep rates from spiking. Senior officials in the Obama administration and at the Fed say they are counting in part on foreigners to keep the housing market funded.
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Nor is Norway's experience encouraging. Its government's holdings of securities issued by the mortgage financier Fannie Mae declined from a 2007 high of more than $15 billion, at current exchange rates, to just more than $5 billion as of Sept. 30, 2009, according to the fund's public reports.
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Even if interest rates begin a modest rise, as he expects, Rajadhyaksha said he does not think it will be enough for sovereign wealth funds to direct large amounts of money away from alternatives, particularly U.S. Treasury notes, that are less risky and not associated with the mortgage crisis.
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Over the past two years, as the world economy cycled from crisis to an uncertain recovery, some sovereign wealth funds were forced to turn inward -- directed by their governments to provide capital to local companies, as in the case of Russia, or pulled back from troubled investments abroad, as in the case of Dubai.

Others signaled a new set of investment interests: commodity and natural resources companies, thought to be undervalued during the economic downturn, and emerging economies that are thought to hold better long-term growth potential than the developed markets of Europe and North America.
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Suresh

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