Analysts are predicting a rise in US interest rates, when the Federal Reserve (FED) stops its policy of buying mortgage backed securities at the end of March, because — say the analysts — the FED’s expectation that foreign government-owned funds will step in to fill the void, will not be realised to the degree the FED is hoping for.
Mortgage backed securities sold by US (lenders) mortgage originators were at the heart of the financial meltdown that we have all just fallen victim to. Any drop in their sale now would damage its fragile recovery, not only by causing a rate-hike, but also by causing liquidity for new mortgages to fall backwards.
For those that do not know, mortgage backed securities are a form of investment. Basically it is where mortgage originators bundle up multiple mortgage deals that they have in place with debtors into pools (also known as being “packaged up”) and sell them to investment funds. The investment model was originally started by the US Federal Reserve, which began buying mortgage bundles from lenders, in order to free up their capital to make more mortgage loans available.
The primary sellers of US mortgage securities on the international market are Fannie Mae and Freddie Mac and the less heard of Ginnie Mae, AKA the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation, and the Government National Mortgage Association, all of which act as guarantors on the payments of the mortgages they sell. Ginnie Mae further guarantees the timely payment of its mortgages. Fannie and Freddie were privatised, but are now once again state-owned.
The primary investors in mortgage backed securities are government-owned funds, AKA Sovereign Wealth Funds. During the last US housing boom, foreign governments invested billions of dollars in mortgage backed securities. The mortgage-holders bundled up in those packages defaulting en-masse, is thought to have been one of the main contributory factors in the collapse of the US banking system, which of course led to the global financial crisis.
So, will foreigner sovereign wealth funds be so quick to jump back onto the MBS wheel? The Fed is obviously banking (pardon the pun) on the answer being yes, but according to experts their desire to buy MBS will not be anywhere near enough to stop interest rates from spiking.
“I don’t think it will be enough to fill the hole,” said Ajay Rajadhyaksha, head of fixed-income strategy for the United States at Barclays Capital.
However, it is also worth bearing in mind that increasing interest rates will increase the yields from mortgage backed securities, which collect the returns from mortgage payments. Therefore an initial drop in securities sales may bring increasing sales as interest rates are pushed up.
Of course any jump in interest rates would hurt the US housing market as it struggles on a rocky path to recovery. But the other effect of a drop in the sale of securities would be just as devastating: that is the very reason why the first sale of mortgage backed securities was made; to generate liquidity for new mortgages within the banking system.
Without doubt the cumulative effect of an interest rate rise, and the availability of credit falling backwards would definitely hurt the US housing market in the short-term. The FED is simply hoping that the increasing revenues from securities as interest rates rise, will combine with the increasing liquidity in the banking system to intensify the recovery in the medium term.
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