Today is Fed day. That sentence means less now than at any point in time than I can remember. The Fed is on hold and they’ve taken every opportunity to tell us they will continue to be on hold for “an extended period of time”. There is no inflation showing up in the economic data, the housing market stinks, unemployment is at 10%, and everyone in the free world is looking over their shoulder for signs of the commercial real estate crisis to emerge.
For the first time in almost a year we have the one-month T Bill trading at a negative yield. As many times as that has happened in the last two years I’ll never get used to seeing it. It’s a bit like an old lady in a hybrid car beating you off the line at the stop light…theoretically you know that it’s possible but you never fathom you’d actually see it (don’t ask me how I know this).
Perhaps the biggest question in the market currently is “what will happen when the Fed exits their MBS purchase program?” That program is scheduled to end in March. A quick bit of history is in order at this point. This MBS purchase program was started as a method of maintaining a very liquid mortgage market in the face of a global liquidity crisis. The large Wall Street firms that normally provided this function were getting hammered with capital write-downs and several large firms went bankrupt. Normally those firms maintained large inventories and had very active trading desks and they served as very efficient market participants that provided deep and liquid pools of capital for the US mortgage market.
As that pool of liquidity began to evaporate, the Fed stepped in to insure that the US mortgage market could operate effectively. A secondary goal of the program was to keep MBS spreads low so that more people could refinance their mortgages. If good borrowers could refi their mortgages then they’d have more spending money in their pocket each month; this in turn would boost consumer spending and help speed the economic recovery. Another goal was to help borrowers in exotic and unaffordable mortgages transition into traditional and more affordable fixed rate mortgages at low rates. If more of these borrowers could get traditional mortgages it would in theory stem the tide of foreclosures, and therefore limit further home price depreciation.
Sounds easy doesn’t it?
Well it’s not easy…and nobody in the real world thought it would work the way the Fed pitched it. It was a bit of a Hail Mary pass. Go big and hope it works. The way the Fed envisioned it is that by the 3rd quarter of 2009 the markets would be back to their normally efficient state and that they could just hand the baton back to the market and let it do its thing. Over time they would gradually liquidate their positions in an orderly fashion and they’d all look brilliant for averting a housing crisis, helping borrowers, and returning the economy to a path of prosperity.
The 3rd Quarter 2009 deadline has long since passed, the Fed owns roughly 34% of the entire MBS pass through market, the next deadline is approaching and they openly question whether they may need to own even more of the market.
The first time home buyers program is due to end on 30 April 2010. It is difficult to see the Fed doing anything that will cause mortgage rates to rise while the administration still has a program under way to help boost home sales. In fact it’s difficult to see them ending this program at all while the housing market is still in shambles. I’m not saying it’s a good program…I’m just saying that I don’t see them giving up and walking away from it. The Fed needs mortgage rates to remain low…and until there is another entity in the market that can take their place it appears that they are stuck between a rock and a hard place. This program appears destined to be remembered as a very expensive program with very limited results. The real pain of the program has yet to be felt as the Fed hasn’t had to deal with owning $800 billion of long mortgages while rates are rising. I’d love to be a fly on the wall when they look at their up 300 rate shock.
Who will take their place?
It’s very interesting to me that they Fed wants to get out of this position as the largest participant in the MBS market, but at the same time the administration is beginning to wage a war on the very institutions that the Fed needs to take their place. The more restrictions the government places on the banks the less able and/or willing they will be to step in to take the place of the Fed in the MBS market.
As a wild card scenario, it could evolve that the Fed ends their MBS purchase program to test the waters, only to have Fannie or Freddie pick up where they left off if mortgage rates rise too much. Fannie and Freddie now have unlimited capital lines from the US Government. The end result would be no different…it would just be a different government entity manipulating the market.
It’s very difficult to see an exit point for government involvement in the mortgage market any time in the near future. I still see rhetoric about helping borrowers in unaffordable mortgages, modifying mortgages, reducing payments and principal balances, etc. I’m not hearing anything in the news that leads me to believe that the government thinks that LESS involvement is the best course of action. NOBODY even mentions “equilibrium levels” or “supply and demand” when they discuss the housing market.
I think it would be very refreshing to see someone go “off script” at a news conference and say something along the lines of “The housing market will continue to be a complicated mess until we get out of its way and allow prices to reach a level where buyers are interested. An unfortunate and painful fact in this process is that some people will lose their status as homeowners, but it’s not fair to raise taxes on those that CAN afford their home so that we can keep the dream alive for those that can’t.” I know…I’m dreaming. Instead we’ll continue to get programs that ask the taxpayer and the lender to eat the loss.
Stimulus Bill update
We have a mall attached to our office, the mall has a food court, we sometimes get lunch there. In the food court there was a Steak Escape restaurant. Through the magic of the $787 billion stimulus bill the owners of the Steak Escape were able to close the franchise and re-open under a new name. They weren’t going out of business…they just changed the name. These jobs get counted as “saved or created” at an average cost of $1.2 million per job.
So the government spent $787 billion to insure that I was able to get a sandwich yesterday from the same people, in the same location, serving the same food as I was able to get a month ago. I thought the sandwich was expensive at $7.49 for the combo meal…but considering that they had about $10 million worth of stimulus bill employees serving lunch I really feel like I got a deal.
I don’t even want to think about how many steak sandwiches they have to serve before the government breaks even on the investment. Who knows…maybe they’ll give a free sandwich to all taxpayers on April 15th.
If you have any questions or if there is anything I can be doing for you just let me know.
Steve Scaramastro, SVP
800-311-0707
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