Unintended Consequences of The Fed's QE3 (MBS Buying Program)

Last week, Fed Chair Ben Bernanke announced QE3 via monthly purchase of $40 billion per month of agency mortgage-backed securities (MBS).

The intended consequences of QE-MBS is to move mortgage rates lower in the hopes of stimulating mortgage refinancings and home purchases. Given tight credit standards from Fannie Mae and Freddie Mac (and the lack of bank lending for their portfolios), it is doubtful that mortgage purchase applications will rise significantly.

Clearly, The Fed has gone all out to support the Obama Administration’s 14 mortgage refinancing programs (HAMP, HARP, Attorneys General Settlement, etc.). I call this shadow fiscal policy by The Fed. But will it really help?

A big problem facing mortgage servicers is capacity. If The Fed is successful in pushing down mortgage rates significantly, the servicers may be hog-tied by lack of capacity, according to Tracy Alloway et al in their Financial Times article entitled “QE3 hit by mortgage processing delays.” Mortgage refinancings could be delay up to 3 months or more.

The Fannie Mae 30 year current coupon rate over 10 year Treasuries has fallen from over 100 basis points to 35.47 basis points on the announcement of QE-MBS.

Mortgage applications, housing starts and existing home sales are due on Wednesday. Of course, QE-MBS will not impact these numbers, but it will give us a gauge of the housing market’s recovery. Both housing starts and existing home sales are expected to rise.

Across the pond, Spain and Portugal sovereign yields spiked. Central banks like the ECB and Fed can only do so much and fiscal houses must be put in order.

The Treasury needs to keep issuing Treasury bonds to get cash to fund the U.S. Congress annual $1 trillion+ overspend.

Banks, investment funds, etc., can only buy so much government debt. Especially at such low interest rates. They hold a certain amount of it because it’s assumed to be zero-risk, for all intents it’s as low risk as cash. Theoretically, of course.

Can they hold 100% of their assets in government debt ? Of course not. 50% ? No way.

Everybody is about full up on Treasury bonds. How do I know ?

The Fed steps in and buys them on the open market. The Fed now owns trillions worth of government debt.

If there was public appetite for that government debt, it would have been bought by someone else on the open market.

So the Fed buying government-backed mortgage debt is going to mean that some of these banks, funds, etc., will be ready, willing and able to buy some more Treasury bonds from Uncle Sam.

You’ll hear economists, etc., talk like a dutch uncle, but at the end of the day, the government ponzi is desperately trying to borrow more cash with which to operate.

Your local Congresscritter undoubtedly believes that the “economy will naturally rebound at some point and tax revenue will go up”. This is abosolutely true except in cases like this where the debt the government owes has gotten too large. And this time they’ve overdone it.

Can someone explain to me the real need for mortgage backed securities?

If I want to invest in real estate, but I don't want to put all my investment on one property, then I invest in an REIT. My money is pooled with that of thousands of other investors and used to purchase a wide variety of residential and commercial properties across the globe.

The REIT has full ownership in all properties they acquire so they are motivated to manage those properties.

An MBS is partial ownership of some property. How the heck do I get together with all of the other people that own bits of the same property to make sure that that property is managed? This was a problem here in LA where some apartment buildings were partially owned by hundreds of people, most of whom didn't know they owned a stake in those particular buildings. Who calls the plumber when the pipes start to leak? Who makes sure that the rents are collected?

REITs provide a sufficient means for investing in real estate while distributing risks. In what way do MBSs provide more upside or protect against larger drops?

It seems to me that MBSs are just another example of "creative accounting". The only real purpose for MBSs appears to be their ability to mask risk rather than to minimize it.

Of all the investments out there that the Fed could invest in, why would they choose something as risky and ineffective as MBSs?

This has got to be a way for the cronies to skim that last bit of money from the U.S. taxpayer before the whole system crashes.

I hope they collect enough cash that they can use it to insulate the walls of the caves they will be inhabiting while awaiting the end of the apocalypse.

Federal government “guarantee” of mortgages is simply the Federal government inserting itself into an economic transaction.

Person A borrows from Bank X to buy a house, signing a mortgage note to them, receiving the cash which is paid over immediately to buy the house.

What was supposed to have happened:

A contract was willingly entered into by both parties, A and X.
Bank X evaluated person A and assessed how likely they were to receive back all their cash with interest.
Person A evaluated the interest rate they were being charged.
If they both like the deal, they sign.

What happens when corrupt, statist politicians get involved:

When government “guarantees” a mortgage or basket of mortgages, it’s putting IT’S “seal of approval” on the deal. What ? Hmmm.. This can include things like... does the deal discriminate against some favored group. Is the government happy with the way Bank X does business in general.

Once the citizenry tolerates their government granting such approvals, it gives their government a toe in the door to all such transactions.

The banking, real estate and investing industries all start desiring this “official state ok” stamp on mortgages. Who wants a private mortgage when they can get a shiny new “approved”, “certified”, USDA prime beef mortgage ?

The banks and investors fall into the pit of thinking they really have a “risk free” instrument. When really they have a “keep the government off our back” instrument. In exchange for that, they simply have to allow the government to control their loan underwriting. I’ll give you my heart if you handle my bloodflow going forward.

Now, if a particular Congress or administration wants to start helping the people who vote for them to get great mortgages at low rates on properties in nice towns - they simply tack on some regulations to the list of requirements for that government approval.

Congress gets it’s “payback” system to buy votes.

Now say hoards of borrowers default on the “government certified” mortgages. Bankers, investors, government - they all stand around tossing the hot potatoe around. Nobody wants to actually pay the “guaranteed” amount.

Your comments on operating the properties are the telltale sign of scam... errr... corruption. The moment the contracts start getting sold off by the originator (Bank X) then bought and sold as a security, that means at that point the “system” is just a way of musical-chairing securities around that are worth an unknown amount less than their face value.

In the case of MBS, you’re 100% right, it’s all about getting investors to gamble on the unknown loss. In the sum total, the losses, or writedowns of value, were taken here there and around. This is the way free enterprise systems send impaired assets to the financial junkyard for disposal. They can’t be auctioned off, because nobody would bid to “buy” a loss. The losses are simply mixed and matched into batches, like a three-card monte game, then the batches are auctioned off. Well, if you buy them cheap, you might actually be able to wind up with more than you paid down the road, either by reselling or waiting for the end of all the terms. Every time someone sells for less than they paid, they’re one of the “loss-absorbers”, every time someone gains, you’ve got a happy investor. Contrary to communist theory, investing is not a zero-sum game.

IMHO, regarding why the Fed is “really” purchasing them...

all Federally-backed securities are viewed financially as rock-solid, low-risk assets. Institutional investors, financial firms, etc., invest a portion of their portfolios in them.

Once they have enough in their portfolio, they don’t buy more of them.

Meanwhile, Congress keeps needing the Treaury to hock bonds to raise $1 trillion in hard cash every year - billions every day. Who has all that cash ? Who wants to invest in MORE Treasuries ?

By purchasing MBS in the open market, they’re taking them off the hands of institutional investors. At some point, the investors will then be in the mood to buy more of Congress’s bonds.

One needs to keep one’s “eye on the ball”, i.e., the real thing that’s going on: as long as Federal deficit > 0 and Federal surplus = 0, NO Treasuries can be redeemed (principal paid out at maturity) UNLESS NEW BONDS ARE ISSUED TO RAISE CASH. This is called “rolling over” the debt.

Operation twist was a financial act of desperation to put off having to redeem principal for decades. “Hoping” that Congress will run a surplus sometime before the bonds come due ? Sound like a great financial plan from Harvard grads ?

The Fed is trying to keep everything appearing normal to avoid the country going Greek when the government says it’s out of cash.

Democrats are desparate to raise tax rates, Repubs are desperate to lower them, hoping for more total revenue.

Unfortunately, our sick, twisted, statist heaping steaming pile of laws has gotten so insane, along with the mentality of many lawyers and especially judges - that business really can’t rebound until we get back to a more sane legal environment. We’ve also allowed mega-corps to collude with government to create unsurmountable barriers to entry for many markets/industries. This gives large businesses the leverage to increase unit prices far beyond what they would be in a competitive marketplace (”healthcare” is a primary example where prices are utterly, insanely, outrageous). It’s amazing how much money is wasted by big corps who can raise prices at their whim.

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