Fed Considering Slowing Bad Credit Mortgage Securities
Bad credit mortgage loans have not disappeared. A recent report indicated that poor performing mortgage securities were still a concern and the loan modification craze certainly has not helped the subprime mortgage or FHA loan market. The Federal Reserve will probably slow its rate of mortgage-backed securities purchases this year to make room for private investors balking at the most expensive levels for MBS since 1992, according to Credit Suisse on Thursday.
Fed purchases of MBS have helped keep FHA mortgage rates near record lows for months, creating savings for homeowners and a cushion during the U.S. recession. But the U.S. central bank may still begin weaning the market from its support, at least in part, in a bid to raise yields and entice other investors, said Mahesh Swaminathan, a strategist at Credit Suisse in New York. To keep mortgage rates down, the Fed can boost purchases of Treasury debt to reduce U.S. government yields, another key input to home loan levels, he said. “One part of the Fed’s mandate is to broaden participation and get private investors more engaged,” Swaminathan said. “We think the Fed should pool its MBS and Treasury purchase commitments and use its flexibly” to keep rates low.
The Fed, in minutes released on Wednesday from its April policy meeting, said it had left open the possibility of increasing its purchases of mortgage-related and government debt to keep credit flowing and spur the economy.
The Fed has purchased $457 billion in mortgage bonds issued by Fannie Mae, Freddie Mac and Ginnie Mae year-to-date to help boost prices that lenders can get for loans in the secondary market. Since March, the Fed has bought nearly $123 billion in government debt, part of a $300 billion six-month program.
MBS purchases by the Fed have reduced the extra yield on the bonds relative to Treasuries to 0.64 %age point from 1.67 %age points at the start of 2009. By slowing purchases, the Fed would keep MBS prices from being “prohibitively tight” to investors who want to reinvest principal from prepaid bonds, Swaminathan said.
Jack Donahue, head of MBS trading at Jefferies & Co in New York, recommended investors avoid bonds the Fed is buying, which contain loans at currently low interest rates. MBS paying higher coupon rates offer investors the best values, despite greater prepayment risk, he said. “It is hard to fight the Fed,” he added. “The further away from the coupons the Fed is buying, the cheaper.”
The Fed may also be saving some of its $1.25 trillion pledge to support the mortgage market “well into 2010,” to prod a gradual housing recovery, Swaminathan said At the current pace, the MBS purchase program could end by January, he said.
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