Mo’ Money Could Mean Lo’(wer) Rates

by Alex Stenback on March 20, 2008

Treasmort_spread_3 How about some good news about rates for a change?

Wall street journal this AM has up an excellent piece outlining recent moves by Federal regulators that may portend lower rates in the coming weeks and months.

…government-sponsored mortgage investors Fannie Mae and Freddie Mac will enjoy loosened capital requirements, allowing them to pile more mortgage securities onto their balance sheets. Fannie and Freddie could purchase an additional $200 billion of mortgage securities…

Meanwhile, a proposal on which regulators are scheduled to vote would allow the 12 regional Federal Home Loan banks to buy as much as an additional $160 billion in mortgage-backed securities…

Both of these moves are important, and may very well lead to lower mortgage rates.  That’s because in addition to the persistent bugaboo of inflation, rates have been held aloft by one simple fact: There have been too many sellers, and not enough buyers, of mortgage-backed securities. 

Here’s why:

  • Extreme risk aversion has created dearth of buyers for securities backed by home loans.
  • Financial institutions under pressure to raise cash were dumping such securities on the market.

So it follows that the expansion of Fannie, Freddie, and the Federal Home Loan Bank’s capacity to buy mortgage-backed securities should have the dual effect of correcting this imbalance, and assuage the fears of risk-averse market paricipants who’ve been reluctant to buy (or have been dumping) these securities. 

In fact, this has already started to happen, as you can see from the graphic at the top right of this post, which illustrates nicely the fact that the spread between mortgage backed securities and 5 year treasury notes – a key indicator of the markets perceived risk – has been narrowing.

Though this is a good sign, the credit crunch and inflation still loom. Anything can happen.

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