MBS MaDdie Update

09/08/2008

In this issue:

1. What happened last week? (Is a Refi Boom on the horizon?)

2. What is on the agenda for this week?

3. MBSRateWatch updates and news.

1. What happened last week?
We ended the week at some of the best pricing levels of the year even though we lost a little traction on Friday when we ran smack into the 200 day moving average. Traders also started to worry about a possible rate reduction by the FED. Throughout the last quarter it was generally accepted that the FED would have to start to “tighten” their Fed Fund Rate so that they could start to put the brakes on economic growth. The last quarter GDP was revised to a blistering hot 3.3% growth rate.

However, after some dismal economic reports (Such as the unemployment rate rising to 6.1%) traders started to worry that the Fed would have to start to lower their rate to stimulate the economy. Generally, MBSs do not like it when the Fed lowers their rate because it usually leads to growth and inflation. Of course after trading for the week was over….they dropped the bombshell…..

Special Report:

Government Takes Control of Fannie Mae and Freddie Mac

What happened this weekend? Oh, nothing special. Football season is in full swing, the leaves are starting to change, and oh yeah in case you missed it, the Government has stepped in and taken control of the two flagship GSEs: Fannie Mae and Freddie Mac.

On September 7th (after the markets were closed) they made the historical announcement. Here are the major players and what has happened.
Major Players:
Henry Paulson, Treasury Secretary
James Lockhart, Director of the newly created and independent regulator Federal Housing Finance Agency (FHFA)
Ben Bernanke, Chairman Federal Reserve.

What Happened:
Over the past week, all three of the above and many others have summarized that with current market conditions Fannie Mae and Freddie Mac could no longer fulfill their mission of providing stability and liquidity to the residential mortgage market. The two GSEs have been placed under “Conservatorship” and are now under the direct control of FHFA effective September 7, 2008. They are not part of the Federal Government, they are still independent publicly traded corporations.

What this means:
FHFA now controls both boards of Fannie and Freddie. Both of the CEOs have been released and FHFA has appointed two new CEOs. The majority of the remaining management will remain. Both GSE’s will continue to operate as usual but will now have much stronger financial backing. Don’t worry, government employees (think DMV) are not in charge and are not making underwriting decisions. Fannie and Freddie have already tightened their credit and income standards. The loans that have been made under the new stricter guidelines are very sound.

As a result of this take over, the government (aka the tax payers) now have a special preferred stock in these companies which are guaranteed repayment before the current preferred and common stock holders are paid. All dividends are suspended and all political and lobbying efforts by these companies have halted. In return, the government guarantees that these companies will never have a negative net value and will have access to much needed capital. The three main goals of this takeover are: Market Stability, Mortgage Availability, and Tax Payer Protection. To this end, the Treasury will be able to provide capital to these companies as well as purchase some mortgage backed securities (MBSs) issued by Fannie and Freddie that are based on the new, tougher underwriting guidelines. (They will not be buying all of the outstanding mortgages nor will they be bailing out any mortgage companies).

In a nutshell, major investors have been sitting on the fence waiting for something to happen between the GSEs and the government. This “waiting” created major problems for the housing market as foreign investment in our MBSs was very light. This action took all of the uncertainty out of the market and major foreign investors are no longer worried about the solvency of these companies. This opens the door for a flood of new capital into our residential mortgage system which should help with mortgage rates.

What this action does not do:
The tax payers are not “bailing” anyone out. You and I are not buying a bunch of bad loans back from Fannie and Freddie. There is nothing that will stop any foreclosure proceedings and the government will not be reviewing any mortgage applications prior to loan approval. The government action simply stops the market fear by providing a “back stop” and some extra capital to purchase mortgage backed securities so that more funds are available for borrowers that meet the new stricter guidelines.

All in all this is a positive step and not a permanent one. Jim Lockhart, Director of FHFA states “Conservatorship is the statutory process designed to stabilize a troubled institution with the objective of returning these entities to normal operations”. He also stated “we will continue until the GSEs have stabilized”. So this is not a permanent solution. Treasury Secretary Paulson calls it “a financial time-out”.

What does this mean to your local real estate market and your average home buyer?
Basically, nothing much. The whole idea of this action is to make sure that mortgage companies can continue to provide low cost mortgages to the credit-worthy. And with interest rates in the low sixes, we need to remember that money is very cheap right now.

It is important for you to know that the ONLY real reason why this happened was to protect the secondary market and mortgage-backed securities. I hope you have finally realized that the MBSs are what drive our industry. Without them you do not have a job. Originators that take the time to learn about the sole source of their funding (and ultimately their commission) will be far more successful than those that don’t. Being part of MBSRateWatch is not just about knowing if pricing is going to get better or worse. It is also about being in “the know” about everything that can impact the real engine of our profession…..mortgage-backed securities.

Refi Boom? That’s right…you heard it here first.
Believe it or not….the potential is here (probably in the next 30 or 60 days). Many good originators have been hanging on by the skin of their teeth. We have been hoping that we can make it through this rough patch until things got better. The idea is that a good chunk of our competition will be gone and we will be in perfect position for the next big thing.

Well, this could be it. I warned you last week that China was quietly reducing their investment in MBSs by as much as 25% (and they are not the only country doing this). This was very bad news for our secondary market because demand for our MBSs was on a steady slide downward which would mean higher mortgage rates regardless of any economic data. Now that Fannie and Freddie are under conservatorship foreign investors such as China will now have more confidence in our mortgage backed securities and will begin to purchase more of them. It also means that the Treasury will begin to purchase brand new MBSs (based upon the new loan pools that have very low risk…no purchasing of old MBS pools) which means that we now have even more demand for our MBSs. This will ultimately cause mortgage rates to decline. Currently major wholesalers like Flagstar Bank have their 6.00% 30 year fixed rate at par. You could very easily start to see 30 year fixed rates below 6.0%.

2. What is on the agenda this week?

This week will set the tone for our next trend. If the reports this week show any weakness (or generally anti-inflationary data) we could see some great rates.

A word of caution though….this could be a very volatile week. Fannie and Freddie have never been taken over before. This is uncharted territory. The market hasn’t even had time to react to what happened this weekend. So, make sure that you are monitoring pricing very closely on our Market Data page. We will be out of the woods after the PPI report is released on Sept 12th. Then we will know what our new short and long term trends are.

We also have a coupon rollover today. The net effect is about -38BPS. So simply add 38BPS to today’s pricing to compare it to Friday’s trend. We will now monitor the October Fannie Mae 6.00% coupon. Some other sites have switched to monitoring the Fannie Mae 5.5% coupon. We feel this is premature but will switch over if your investors are purchasing more 5.5% bonds than 6.0% bonds.

Our pre-market Status= Floating for intra-day monitoring.
Our long-term Status = Floating.

3. MBSRateWatch updates and news

We now have four moving averages on our candlestick graph. We have added the 200 day and 10 day averages.

Have a great day!
www.MBSRateWatch.com
800-264-7135