Consumer Primer On Interest Rate ‘Carry Trade’. Last Day For Federal Tax Credit, CA Credit Still Live

Last Day For Federal Tax Credit, CA Credit Still Live
Today the $8,000 tax credit for first-time home buyers and the $6,500 tax credit for repeat home buyers expires. Service members, however, who were on official extended duty outside of the United States for at least 90 days between Jan.1, 2009 and May 1, 2010, may qualify for a one-year extension. If a binding sales contract is signed by today, home buyers have until June 30, 2010 to complete the purchase – remember that investors are not guaranteeing any funding dates! Here’s more information on Federal as well as CA tax credits.

Signs of Life In MBS Market
There continues to be some press regarding good news in the secondary markets for mortgages (the primary market, of course, being the interaction at the origination level):

Wells Fargo recently received some press about absorbing Wachovia’s trading group and using it in building a team to package and trade mortgage-backed securities, similar to operations at BofA and Chase. The trading partners have diminished, and Wells is hoping to help their clients avoid reliance on the remaining “Wall Street” competitors and use Wells to structure and market MBS securities for them while doing the same for Wells’ own mortgages.

And of course the $222.4 million Redwood/Citi sale recently included jumbo creampuff mortgages, but it was definitely a very good step.

Consumer Primer On Interest Rate ‘Carry Trade’
What is the “Carry Trade”, and why should unwinding it be a concern? The low interest rate environment in the US, both overnight and long-term, has provided a big boost for the carry trade. This is the nickname for where large investors can borrow at very low rates, and leverage into higher yields, resulting in huge returns. An investor can buy a $1 million bond yielding 5%, and earn $50,000 per year in interest. But in order to make the purchase, the investor puts up only 10% of $1M, or $100,000 in cash, and borrows the other $900,000 at the Fed Funds rate (.25%) + a 2% margin, for example – which would be a borrowing cost of 2.25% or $20,250. This investor receives a $50,000 return, but subtracts a $20,250 cost to borrow $900,000 – leaving them with a net return of $29,750. Remember, the investor needed only to invest 10% of the $1M purchase – or $100,000 in cash. This gives the investor a great 29.75% return on their investment. And of course, this “carry trade” can be used in other securities as well.

Of course when the Fed starts to raise overnight rates (“tightening”) this can cause that yield and income cushion to quickly evaporate. On top of that, if rates go up, yields go down, and the value of the bond goes down. This is why investors pay such close attention to the odds of the Fed raising Fed Funds. When the press release says that it will keep rates low for an “extended period” that helps institutions continue on with the carry trade.

Greece and Treasury Auction Updates
Yesterday’s $32 billion 7-yr Treasury Note auction went well, with yields coming in about at market yields on a bid-to-cover ratio of 2.82 times the amount on offer, beating the long-run average of about 2.6. The news out of Greece didn’t seem to shake up the markets too much as that country readied severe austerity measures to secure a multi-billion euro aid package needed to avoid default, providing relief to financial markets but drawing threats of a battle from Greek unions. In shades of what we may see in other countries and maybe the US eventually, Greece may raise sales taxes, scrap salary bonuses amounting to two extra months of pay in the public sector and accept a three-year pay freeze.

+3.2% GDP Better On Consumption
For those watching the mortgage markets, yesterday was pretty quiet relative to Tuesday and Wednesday. Apparently supply (rate locks) dropped somewhat yesterday, and with lower volatility brought less buying and selling of mortgage-backed securities. A few ticks (32nds in price) here or there don’t matter much – one trader said trading was “half the flow and half the volatility of Wednesday”. For economic news today there are no auctions or policy speeches. At 8:30AM EST we had Real GDP. 1st Quarter Advance GDP number came in at +3.2%, less than expected, but +3.6% on consumption, stronger than expected. Later, at 9:45AM EST, we have the Chicago Purchasing Managers index for April (forecast at 60.0 vs. 58.8 previously), and the April final reading on the University of Michigan Consumer Confidence survey (also expected to move higher). The 10-yr didn’t move much, hovering around 3.74%, and mortgage prices this morning are roughly unchanged, maybe down a tad from Thursday afternoon.

Daily Humor
The Psychiatrist and Proctologist
Two doctors, a psychiatrist and a proctologist, opened an office in a small town and put up a sign reading: “Dr. Smith and Dr. Jones: Hysterias and Posteriors.”

The town council was not happy with the sign, so the doctors changed it to read, “Schizoids and Hemorrhoids.”

This was not acceptable either, so in an effort to satisfy the council, they changed the sign to “Catatonics and
High Colonics.” No go.

Next, they tried “Manic Depressives and Anal Retentives.” Thumbs down again.

Then came “Minds and Behinds.” Still no good.

Another attempt resulted in “Lost Souls and Butt Holes.”

Unacceptable again!

So they tried “Analysis and Anal Cysts.” Not a chance.

“Nuts and Butts?” No way.

“Freaks and Cheeks?” Still no go.

“Loons and Moons?” Forget it.

Almost at their wit’s end, the doctors finally came up with:

“Dr. Smith and Dr. Jones, Odds and Ends.”

Everyone loved it.