My Charlottesville BLOG

The below information is posted (with permission) courtesy of Ty Smith at SunTrust Mortgage in Charlottesville Virginia.

(my comments follow)

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The announcements over the weekend that FNMA and FHLMC are being placed under the conservatorship of their regulator and will receive large capital infusions from the Treasury are an extremely positive development for the mortgage market, housing, and the economy. If nothing else, these moves reduce the risk of mortgage rates continuing to drift higher as a desperate FNMA and FHLMC sell MBS and increase fees to raise capital. But there are early indications these changes will have a substantially more positive effect on mortgage rates by bringing all sorts of investors back to the agency MBS market. Here’s a look at what was announced and what we can expect as a result.

• As conservator, the FHFA assumes the powers of the Board of Directors and assumes responsibility for management of the two agencies.
• The two CEOs of the GSEs have been replaced.
• The Treasury will purchase up to $100 billion of senior preferred equity. The taxpayers’ investment will be senior to current preferred and common stockholders, but junior to all debt holders. An initial investment of $1 billion each will be made with future investments made as necessary to maintain solvency.
• The GSEs will also be able to borrow under a credit facility provided by the New York Fed through 2009.
• The GSEs will be allowed to grow their retained MBS portfolios to $850 billion by the end of 2009 but must then reduce them to $250 billion over the following 12 years.
• In addition to GSE portfolio growth, the Treasury will begin directly purchasing an undefined amount of agency MBS through 2009.

There are two important themes running through Treasury Secretary Paulson’s announcement this weekend. First, the scale of the plan – substantial equity investment plus a credit facility plus direct purchases of MBS – seems to be his way of saying to global markets, “Do I make myself clear this time?” As you recall, the questions that arose after the passage of the Housing Bill seemed to backfire and cause MBS yields to move higher despite the authority given the Treasury to invest in the GSEs. We speculated then that Secretary Paulson wouldn’t want to make that same mistake twice and he didn’t. All of the plan’s elements are intended to make it unmistakable that resources much greater than what likely will be necessary are immediately available to ensure debt holders are secure, MBS investors are secure, and the GSE will continue uninterrupted operations.

The second theme is the need for structural reform of the GSEs including their purpose and the degree of government support they should receive. We’ve talked about the incompatibility of the GSE’s conflicting mandates: maximizing shareholder returns while pursuing public missions. Secretary Paulson clearly warned these two objectives cannot coexist and it should be a priority of the next Congress to rectify the situation. He also addressed the need to clearly decide if the GSEs should be backstopped by the government or completely privatized. In his words, the government guarantee should be explicit or non-existent with each having its economic and social pros and cons that lawmakers will need to weigh. This part of his speech seemed to say, “I can’t make the decision; only Congress can. But it needs to be made or we’ll end-up back here again one day,” making the upcoming elections critical to the future of our industry. What does all this mean for us right now? Here are a few thoughts:

• For the most part, it’s “business as usual.” The stated goal of the Treasury and FHFA is that for now there should be no meaningful interruption in the flow of mortgages to consumers. However, the outcome of those big thorny questions Secretary Paulson left in the lap of the next Congress could mean more changes to come down the road (more on that in future updates).
• As we’ve discussed, if some or all of the recent widening in MBS yields versus Treasury yields decreases as more investors come back to the MBS market, we could see a decrease in mortgage spreads of 50 to 60 bps. In fact , on September 8 MBS yield spreads over the 10 year Treasury went from approx. 200 bps down to approx. 150 bps. That’s the largest one-day move in the MBS-to-Treasury basis ever recorded.
• However, as investors sell Treasuries in order to buy MBS and other assets (a “reverse flight to quality”) we should not be surprised if increased Treasury yields offset some of the MBS spread improvement. The move higher in Treasury rates could be made worse by fear the Treasury will need to increase its issuance of debt to pay for the MBS it buys and to pay for the preferred equity it purchases in the two GSEs. We saw Treasury yields increase early in the day Monday but then saw a reversal with Treasury prices recovering much of their lost ground by the end of the day. Keep in mind, recent employment data was dismal and indicates further weakness in the economy. A strengthening dollar and lower oil prices are also disinflationary. These developments, combined with the Government’s express desire to keep mortgages affordable, suggest we need to keep a bias toward lower mortgage rates.
• The relatively large differences we’ve seen between FNMA MBS yields and GNMA MBS yields should collapse as the creditworthiness of FNMA becomes more like GNMA. We’ve seen this already and should expect some shift in our originations back to agency products.
• There’s a lot of news for market participants – banks, money managers, hedge funds, sovereign wealth funds, mortgage servicing hedgers, etc. – to digest. Each will assimilate the news in his/her own way and at his/her own pace. That means it could take days for the market to fully price in its thoughts on where MBS and Treasury yields need to be. In the meantime, given that market makers are still reluctant to put a lot of capital into MBS positions, market volatility in both directions will remain very high and consequently hedge costs will be extremely high.

With this weekend’s announcements, a chapter in our industry’s history closed and a new one began. There’s every reason to believe that the next chapter for FNMA and FHLMC will bring improvements that ultimately lead to an even stronger mortgage finance system. FNMA and FHLMC are loyal business partners full of talented professionals and once their new missions are clarified, we can expect great contributions to the future of mortgage finance. But this story will take some time – maybe years – to be completely told and in the meantime, critical first steps have been taken to restoring normalcy to the MBS markets.

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The important thing when dealing with financing is to have an expert in your corner. People are still buying and selling Charlottesville Real Estate everyday and will continue to do so.

About The Author

Charles McDonald, Associate Broker at RE/MAX Assured Properties and dedicated Buyers Agent is the author of this blog, and several other sites on the Internet. Charles and his team of experts in the Charlottesville area are always available to help you with your Real Estate needs. Call our team anytime at 434-981-1585 or to search for homes visit: Charlottesville Real Estate

 Copyright © 2008 Charles McDonald, All Rights Reserved. 

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