The Securitization Market is Still Frozen

I saw this over at FT Alphaville over the past week, and it’s a huge question:

FT Alphaville has worried before about what might happen once the Federal Reserve ends its $1.25 trillion buying-spree of mortgage-backed securities (MBS). The central bank is due to stop buying MBS in March, when it ends its quantitative easing (QE) is scheduled to end.

via FT Alphaville » Filling the central bank void.

Then I saw this table in the post:

Which made me go back to this:

So those volumes are down, despite the Fed’s willingness to come in and buy these mortgages at prices nobody else will pay. Combining the table and the chart, it really brought to my attention something I had assumed to be true for a while, but didn’t have any data to back it up until now:

The securitization markets are frozen and are in a deeper freeze than when the Fed started QE because nobody will support the prices/valuations the Fed has been assigning to the MBS it has purchased.

See, what gets lost in all of the talk about housing, credit, evil banksters, and everything else tied to this crisis is one of the factors that really drove the credit bubble: the promise of liquefication of the balance sheet. Loans of all stripes (auto, mortgage, credit card) used to be rather illiquid assets. If you made the loan you kept the loan. But with the advent of securitization, that idea became archaic. Byzantine. With an active market, a plethora of participants to trade with and product to trade in, price discovery for mortgages (either whole loan or securitized) is a simple affair.

That is, until it isn’t. We started to see those issues crop up in late ’06 with mortgage originators hitting the wall and filing for bankruptcy, and it just got worse.

Enter the Fed. They announce their intent to purchase MBS and act like fools, rushing in where angels fear to tread. It has the one effect they wanted, a dramatic bull steepening of the yield curve:

Which brings me to a question, but here are some thoughts, first. The yield curve is grossly distorted at the front-end in my mind. To me, it needs to be downward sloping at the front-end to really show the risk in the bond market. Wells Fargo sees it the same way.

But what should the shape be? If you assume the 30yr rate is fixed, that could mean the rest of the curve rises. Nearly 500bps just to flatten, higher if you believe it should be inverted and the 30yr rate is anchored. That would be the death of us all.

In my view, the 30yr needs to come in some, while the front-end needs to go much higher. But is there a pivot somewhere between the 5yr and 10yr points on the curve? I don’t think you can rule that out.

But in the meantime, the Fed is shutting down the liquidity spigot. That’s all fine and dandy. But why do I get the feeling we could see them step back in before the end of the year and commit to purchasing even more the next time around? Because by that point, it would be obvious to everyone there’s only one bid in the market, and it’s the Fed. But think about what’s actually happening to the market for securitized loans.

It’s suffocating. All at the hands of the people who want to see it revitalized the most…

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Filed under finance, government, macro, Markets, Way Forward

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