THE BASIS POINT

Who’s Carrying MBS Market (besides the Fed)?

The markets find themselves in a sustained period without Treasury supply/auctions, Europe being relatively quiet, and better signals from our economy.

Even with a slight rate rise, no one is complaining about mortgage rates, but remember in the old days when the Fed wasn’t buying $1.2 billion of MBS’s every day?

Two Federal Reserve officials (Bullard and Plosser) recently opposed additional mortgage-bond purchases by the Fed, saying the measure isn’t needed and that the U.S. central bank shouldn’t interfere in credit markets. But Fed officials are keeping open the option of a third round of bond purchases in case the economy weakens or inflation stays low.

So who is going to buy the Fannie/Freddie/FHA MBS stuff that loan agents everywhere are originating?

Overseas investor holdings of agency MBS have declined from $773 billion to $583 billion from June 2008 to December 2011, per TIC data. Estimates show that China’s holdings of agency MBS alone have declined by $170-$180bn since hitting their peak in 2008 – in terms of face value – which explains almost all of the decline in overseas holdings of agency MBS since the middle of 2008. In fact, if one takes out China, overseas investors actually increased their agency MBS holdings in 2011.

MBS markets continue to perform well. That is, as long as the Fed keeps buying $1.2b of Fannie/Freddie MBS per day. Given the NY Fed’s figures, the purchases covered just over 70% of the originator supply last week. My daughter’s high school economics class can tell you that if the Fed stops using pay-down money to buy new mortgages, and supply remains constant, agency prices will drop and rates will go up.