Housing Doom commenter coffee just dropped this in the comments. Twist and I are over our heads on this one. I’ll put a few of the relevant news links up in the comments later, but in the meanwhile any assistance would be appreciated. This is about the latest Treasury moves to force down mortgage rates. They seem awfully radical to me.
PSA: measures prepayment risk in a mortgage back security. PSA is the implied prepayment risk model at a specific yield. It measures the risk to the investor’s cash flow disappearing due to prepayment risk.
I do not have a bloomberg, so somebody might be able to get us today’s “PSA” on the 6% mortgage back. I would not be surprised if it exploded to over 1,000 today. normal PSA is 100
Think what will happen to all the 6% mortgage back securities backed by AAA collateral and clients, 740 plus Fico and sub 80% Loan To Value? They will dump the 6% and get a 4.5% mortgage. Mortgage backs Carry a fixed cash flow. Pricing theory has it that with a 100 PSA; as rates drop the note value rises. With a very high PSA; reality is the value of the 6% MBA collapses with the rate dropping.
With a very high PSA as rates drop the value of the Mortgage back also drops as the prepayment of current mortgages rise and investors lose their interest income or cash flow due to refinancing.
The effect is Agency paper over 4.5% (5.0,-6.0,-6.5)will drop in value even as rates drop in value. Agencies (Lenders) are Hedged with short T.treasuries against long agency paper.
With the scenario the treasury is proposing lenders will get killed as their agency paper drops in value and their short treasuries will go up in value. Many lenders will be forced into bankruptcy.
Unintended consequence.
http://www.yourdictionary.com/psa-prepayment-speed
OK, guys, over to you!
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Partial list of the many stories relating to this. I’ll add from time to time. Meanwhile here’s the relevant Google News cluster, just 11 stories to now but ranks 2nd on the Google News Business page.
“US mortgage applications post largest gain ever”, by Julie Haviv, Reuters, December 3, 2008.
“Pimco’s Gross: 30-Year Mortgage Rate May Fall to 4.5%”, by Andrew Fisher, CNBC (includes video interview), December 3, 2008.
“Financial industry pushes for lower mortgage rates”, by Christopher S. Rugaber and Alan Zibel, Associated Press, December 3, 2008.
“U.S. Eyes Plan to Lift Home Sales: Treasury Considers Encouraging Banks to Offer Mortgages at Rates as Low as 4.5%”, by Deborah Solomon and Damian Paletta, Wall Street Journal, December 3, 2008.
“A Rush Into Refinancing as Mortgage Rates Fall”, by Tara Siegel Bernard, New York Times, December 3, 2008.
Something just happened. Probably won’t be blogging much tomorrow.
Indeed. I think the solution will be to give 4.5% rates for new mortgages, but not allow refinancings.
That would have the double benefits of rewarding responsible bubble-sitters and not blowing up the MBS holders.
So the prepayment risk means that as MBS investor, you risk people prepaying the mortgage because you have been counting on this stream of income. Since new mortgages will be at 4.5%, nobody wants to keep thier 6% loans anymore. They will try whatever to get rid of the 6% morgaged house and take on a new 4.5% mortgage.
Treasury believes that they can distinguish between new purchases and refinance. I say that’s bs. Say, my neighbor and i both have the same type of home at 6%. We can just sell each other our houses twice in a row and magic! all of a sudden our loan dropps to 4.5%!
Do they think people are idiots?
Cfishy-
Yes, they do. That’s the excuse for bailing out all the homeowners. Who could have known that using a wonky loan in an overheated market was a risky investment?
“[L]enders will get killed as their agency paper drops in value and their short treasuries will go up(sic)in value.”
Correction: In an environment of falling interest rates, the banks’ short Treasury position will create losses for their long/short straddle strategy.
This will create a renewed credit contraction because of falling asset values in the affected banks’ balance sheets, which is a sure-fire formula for a double-dip recession, just like the one we had in the 1980s.
Unlike then, however, there will be no further room for interest rate cuts. As such, the second leg of the recession will not result in a “W” but will instead produce an “L” shaped recession–a persistently lower living standard.
We are on the threshold of a secular bear market that could last for decades.
Here’s a solution: 4.5% for first-time buyers only. It solves the MBS problem and rewards the responsible.
Money is fungible and you can not differentiate between a Refi and a Purchase. Do you think lenders will create a two tier system of cost of money?
The Treasury is artificially pricing out the risk of a mortgage and transferring it to the tax payer, the public. The Treasury is not a public entity. Bernake is should not be able to buy mortgages at prices determined by him to be fair at tax payers expense.