Understanding mortgage-backed securities

Almost right. 1. Banks carried mortgages at first. 2. Then banks packaged and sold mortgages to agencies (FMAC, GNMA). 3. Finally, as the film states banks package mortgages for the derivatives market.

Fiscal Crisis 2013
Keeping The Options Open

As always there are trades offs. The Federal Reserved increased the spread between long and short term borrowing rates to encourage financial markets to lend, and help unfreeze capitol markets. Lenders are also less inclined to retain paper in a low interest rate environment with the possibility of rising inflation. These spreads provide an incentive and help offset the risk to lenders in sluggish economy with a engineered low interest rate.

Still, the Federal Reserve also knows with each interest rate reduction more of the population can qualify to borrow, possibly stimulating consumption further.

As always the pendulum swings, and then it becomes a matter of pursuing economic theory to a possible extreme. The current Federal Reserve policy had already impeded money market fund yields with the expected results. Some analyst felt that the Federal Reserve should pursue equilibrium in October 2012 by returning to the short end of the bond prior to the expiration of Operation Twist to maintain the above spread while continuing to pursue a low interest environment. Not maintaining this spread may be kicking down the first domino in a sequence of events that could yield a economic contraction in 2013. Observation, prudence, or conjecture?

It would remain in the best interest of the economy for the Federal Reserve to remain flexible and allow these windows to continue to open and close periodically rather than nailing these windows open or closed.

There are two sides and a middle to a coin. The Federal Reserve venture into mortgage back securities has displaced participants’ in this market. This should not be an inquisition by the Federal Reserve to determine who should survive in this business and who shouldn’t. There is also uncertainty as to the impact of the Federal Reserve unwinding their positions since no one can predict with certainty what will happen in the future.

Financial literacy may be worth a full point in interest rate deductions. Rather than impact this market further for another half point interest rate reduction it maybe in the community’s best interest to consider other strategies. One strategy is to help consumers become better borrowers. Homebuilders have begun credit boot camps to help consumers understand debt, prioritize payments to increase their credit scores, and repair their credit.

The uncertainty of interest rates rising a few hundred basis points is also a concern, so stability is an absolute necessity. After all is said and done the Federal Reserve is about economic stability.

Residential Mortgage Back Security principle and interest are guaranteed by the government. The Federal Reserve is a big buyer. Short term this is like first rain in the desert. In the near future spreads will continue to fluctuate providing windows of opportunity. There are concerns beyond 2014 when economics, supply, spreads, risk, and FED policy comes full circle.