Fed, MBS and You

1. Fed, MBS and You “When the facts change, I change my mind” – John Maynard Keynes

2. Objectives • 1. An update on the fundamentals of the U.S. housing market • 2. Analyze the effect of the end of the MBS purchases on credit markets and long term rates • 3. A look at the current MBS holdings of the Fed and a viable exit strategy to these positions.

3. New Home Sales • Up 26.9% in March, 411,000 annualized units

4. Home Sales Jump in the South

5. Tax Credit

6. Existing Home Sales

7. Housing Prices Stable

8. “Glut of Trouble” – WSJ • "How much of the strength in the housing market is just the perception of government support?" he said. "I do have concern about a double dip.“ – Robert Shiller (Yale) • At the current rate of sales, it would take almost nine years to work through both the real and "shadow" inventory. • “Supply >> Demand” – Goldman Sachs

9. What is a Mortgage Backed Security (MBS) • RMBS – Residential Mortgage Backed Securities • CMBS – Commercial Mortgage Backed Securities • CDO – Collateralized Debt Obligation

10. Main Credit Indices • ABX.PRIME.AGG • What have treasurys done? • What have 30 yr rates done

11. 30 yr Fixed - National Average

12. 30 to Treasury Spreads

13. Long term real rates

14. CMBS Delinquency (CRE Market) • RealPoint: March delinquencies hit an all time high up 6% • TREPP: This number is even worse, at nearly 8%, after the single biggest monthly spike in 30 day + delinquencies.

15. Prime RMBS Delinquency • U.S. Prime RMBS delinquency now over 10% • Increased for 34th consecutive month • Jumbo RMBS delinquincy 10.1% in Mar (up from 4.8% yoy) • Subprime RMBS delinquency rate actually fell in Mar • 46.3 from 46.9 in Feb, but still well over 39.8 yoy • First decline in 4 years! (Could be seasonal anomaly

16. Spreads

17. Fed MBS Purchase Program • GSE Agency Guarantees - Fannie, Freddie, Ginnie Mae explicitly guaranteed by the govt. • What is the purpose of these guarantees, when/why did they start • Goal to help lower borrowing costs • $15-25 B a week! • Purchases as a share of gross issuance have ranged around 60 percent

18. Fed Holdings of MBS • At $1.1 trillion in holdings of mortgage debt guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae, the Fed owns roughly a fifth of all these outstanding instruments.

19. Current Balance Sheet

20. Video

21. What can you do with 1.1 T MBS? • Reverse Repo - Temporarily drains funds from system • Dealers offer interest rates at which they would lend money to the Fed versus the Fed’s Treasury general collateral (MBS) • Hold to Maturity • Sell on Market

22. Hold to Maturity • Fed has indicated these purchases were a temporary measure to stabilize the housing market and will be off-loaded to public hands as soon as possible. • Positions were bought on the cheap and have been profitable. • As rates rise, positions will fall in value

23. Fed’s Interest Rate Exposure • Fed’s DV01 is $1-1.5 Billion (Gain/loss per BP) – Alan Boyce, former Fed member • ≈75 Billion loss for first 50 bps, • What is the cost of hedging? • Interest rate swaptions, 3yr into 7yr • 142 Billion – according to professional MBS trader • Fed doesn’t mark to market, but on a cash basis they go negative carry in 2015 (3 mo financing rates go above 5%)

24. Sell SellSell • 81.5% of their portfolio is 30yr 4.0 coupons,4.5 coupons, and 5.0 coupons. • If the Fed decided to sell they would drastically erode the value of their own holdings. Overwhelm market

25. Takeaways From Ben’s Testimony • When Fed begins to sell assets, must do it in a gradual, predictable way (communication and transparency) • Fed not adding any credit risk by holding GSE MBS(because underwriting standards much tighter in 2009 and 2010) • Fed would like to get back to all-treasury portfolio in reasonable period. • Fed will be returning “Unusually Large" amount of money to Treasury in near term due to mortgage investments.

26. Questions?