Mortgage Market Distress Causing Rates To Rise

A: If you are watching CNBC or reading up on some headlines on Bloomberg, you probably can sense the fear level that is gripping the secondary mortgage markets! The problems have been bubbling under the surface for weeks and it seems that it can no longer be contained. The seizing up of these markets is causing companies like Thornburg & Carlyle to miss margin calls and receive default letters. The ugliness is a combination of fear, illiquidity, risk aversion, de-leveraging, and risk repricing; so expect sharp movements both up & down as the correction process continues. The unfortunate side effect is higher lending rates.

Have you seen the spreads between gov't backed conforming paper & 10 year treasuries! Even the safest paper is seeing risk aversion as a result of the credit turmoil. According to Bloomberg's article, "Agency Mortgage-Bond Spreads Rise; Markets 'Utterly Unhinged'":

The difference in yields, or spread, on the Bloomberg index for Fannie Mae's current-coupon, 30-year fixed-rate mortgage bonds and 10-year government notes widened about 7 basis points, to 223 basis points, the highest since 1986 and 89 basis points higher than Jan. 15. The spread helps determine the interest rate homeowners pay on new prime mortgages of $417,000 or less. The markets have become "utterly unhinged," William O'Donnell, a UBS AG government bond strategist in Stamford, Connecticut, wrote in a note to clients today. A lack of liquidity has "led to stunning air-pockets in price levels."

Investors are realizing that banks have little room to make new investments amid rising losses and a flood of unwanted assets, said Scott Simon, head of mortgage-backed bonds at Pacific Investment Management Co. The world's top banks have reported more than $181 billion in asset writedowns and losses, been stuck with $160 billion of leveraged buyout loans, and bailed out $159 billion of structured investment vehicles.

"Everything is telling you the financial system is broken," Simon, whose Newport Beach, California-based unit of Allianz SE manages the world's largest bond fund, said in a telephone interview today. "Everybody's in de-levering mode." Agency mortgage securities outstanding, which are guaranteed by government-chartered Fannie Mae and Freddie Mac or federal agency Ginnie Mae, total almost $4.5 trillion, about the same size as the U.S. Treasury market.

I discussed the effect on lending rates this two weeks ago in my post, "Inflation + Credit Crunch Means Higher Mortgage Rates":

"...this credit storm is now a full blown category 5 hurricane on so many levels and is hitting land at numerous points; analogy --> credit crisis is spreading! Put both these FACTS together and you will understand why lending rates are rising."

To the right is a 1-Month chart (courtesy of Bankrate.com) showing you 30YR Fixed Jumbo NY, 5/1 ARM NY, & FNMA 30YR MTG Yield. While the green & blue lines (the 30YR & 5/1 ARM respectively) seem to only slightly trend higher, take a look at the left axis and you will see that these yields have risen about 40 basis points & 50 basis points respectively over the past 4 weeks! Then look at what FNMA yields have done! These are the side effects of a secondary mortgage market in distress where risk aversion & fear are starting to effect even the safest paper out there.

All this is occurring as the latest round of housing data comes in and confirms what the credit markets have been deeply concerned about:

a) Home Foreclosures Hit Record High
b) Pending Home Sales Remain at Second-Worst Number on Record
c) Homeowner Equity is at Lowest Since 1945

As usual, the folks at the NAR put their car salesman spin on these disturbing numbers further eroding any credibility they have left. De-leveraging is a bitch and right now that bitch is taking over the cleansing process; it's quite a dirty job. As the credit markets continue to LEAD the stock markets, I am now starting to get more interested in the severity of the slowdown in future economic data reports that will reflect the turmoil that we have experienced over the past 4-6 months.

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