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Why Mortgage Market Bailout Left Everyone Confused

Why Mortgage Market Bailout Left Everyone Confused: QuickTake

(Bloomberg) -- In the U.S. mortgage market, what counts as good news for consumers isn’t always good news for investors, and vice-versa. The pandemic has scrambled those equations even more than usual. That’s meant disappointment for some homeowners and homebuyers, relief for others, strong gains for some investors and potential losses for others, as the mortgage market grapples with the impact of both the economy’s sudden contraction and government steps meant to cushion the shock.

1. What’s happened in the mortgage market?

When stay-at-home orders began in early March, prices on commercial properties fell as investors factored in empty malls and months without brick-and-mortar retail activity. That forced real estate investment trusts, which focus on commercial properties, to start selling off their most liquid mortgage-backed securities (MBS) to meet margin calls, driving yields up and further undermining the market. The U.S. Federal Reserve responded by announcing in mid-March that it would purchase “at least” $500 billion in U.S. Treasuries and $200 billion of mortgages backed by government agencies, so-called agency MBS.

2. What did the Fed do?

Since March 16 alone, the bank has bought over $640 billion of agency MBS, a torrid rate averaging about $15.2 billion per day. While this pace has slowed to a target of about $5 billion per day now, Morgan Stanley pointed out that the Fed’s pace of buying at first was eight times as fast as any previously seen.

Why Mortgage Market Bailout Left Everyone Confused

3. Did that help?

For many mortgage bond investors, the Fed buying spree has been a welcome intervention. One measure that compares the market’s sense of risk for fixed-rate mortgages to a risk-free rate of return has tightened 60 basis points since the Fed went to work. The Bloomberg Barclays U.S. MBS index has gained 2.43% (besting corporates’ 2.16%) and excess return versus Treasuries over that time has equaled 1.42%.

4. Who did it hurt?

In particular, those lenders who use short selling in what’s known as the To-Be-Announced market for agency MBS to hedge risks on the mortgages they are in the process of issuing were put under significant stress. The sudden surge in MBS prices driven by the Fed purchases turned those hedges into costly losses, threatening their capital position as they dealt with margin calls. This partly explains why the Fed has considerably slowed its buying pace of late.

5. What’s happened for consumers?

Some of them can benefit from two government actions. In tandem with the MBS purchases, the Fed has also bought about $1.5 trillion of Treasury debt, sending yields to historic lows. This is good news for U.S. homebuyers as well as homeowners able to refinance their mortgages, who can save money by locking in the new lower rates. And homeowners who have lost their jobs are being helped by a provision in the coronavirus relief legislation passed by Congress (known as the CARES Act), that allows them to demand mortgage forbearance, meaning they can put their monthly home loan payments on hold for up to a year. There are no financial penalties imposed for those who demand forbearance.

6. Are there downsides to any of that?

A wave of refinancings and filings for forbearance would be good for consumers but not for mortgage bond investors. Homeowners refinancing their mortgages return money to MBS holders earlier than expected and at par, or 100 cents on the dollar. That would hurt investor returns, since 30-year MBS are currently trading higher than par. Similarly, when homeowners go into forbearance, that loan could eventually be bought out of the MBS pool, which for an investor has the same effect as a refinancing -- money back at par and earlier than expected. The last two months have seen refinancings for conventional 30-year mortgage bonds rise 26% and 42%, respectively. Meanwhile, forbearance requests have risen to about 8% of outstanding loans from just 0.25% on March 2.

7. What’s the fallout from that for homeowners?

The blowback can mean that lending rates for home loans aren’t as cheap as current Treasury yields would suggest they should be, and that borrowing may be harder than normal for those at the lower end of the credit spectrum. While the yield on the 10-year Treasury note has dropped 1.2 percentage points since the start of the year, mortgage rates have fallen by less than half that amount, reflecting the added risk from higher refinancings and forbearance. And the cost that forbearance places on mortgage servicers -- the companies that funnel homeowners’ payments to bondholders -- will push mortgage rates higher than they otherwise would be. (JPMorgan recently estimated that if 10% of the mortgages demand forbearance, servicers would need to front up to $3 billion per month to bondholders.) Lenders are also expected to react by making it harder for people with lower credit scores to borrow, since they present a higher than average chance of asking for a forbearance.

The Reference Shelf

  • The Consumer Finance Protection Bureau’s page on the mortgage forbearance provision of the CARES Act.
  • An article about homeowners seeking mortgage forbearance.
  • How margin calls wiped out a chance for cheaper mortgages for many Americans.
  • Why potential homebuyers may find it harder to get mortgages now.

©2020 Bloomberg L.P.