MBS Catch-22: Model Portfolio Update

• Gregor Macdonald
• January 27th, 2010

The FED confirmed its intention today to end its MBS purchase program, which saw the uptake of 1.25 trillion in mortgages over the past 9 months, since March of last year. I remain doubtful that the FED will be able to halt this program for long. After all, this operation served a double purpose. Not only did the FED buy most (if not nearly all) of the newly generated conforming mortgages in 2009–which had the effect of keeping mortgage rates low–but, this injection of liquidity enabled existing holders of mortgages to trade them for cash. And what did they do with that cash? Given poor investment prospects during our depression, they bought treasuries.

We can anticipate the problem therefore, during a time of falling wages, no job growth, and confirmation of the next leg down in housing, that is presented by the end of the FED’s MBS program. Not only would it starve the housing market, introducing a shift higher in risk premiums (mortgage rates), but it raises the question: from where will the bid come for the treasury market, which surely will continue to see enormous supply as 2010 rolls onward? To this point, it’s unclear (as it always is) how to best analyze movements in treasury prices these past few weeks. While in one sense…(this article continues for subscribers through the membership gateway, on the right side of this page)

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