Lending at 5% for 30 years seems like a bad deal, except if you compare it to investing in US Treasury bonds at 4.5% for 30 bonds. Taking customer deposits to do so is indeed a bad deal. The technical term for it is disintermediation, and it was one of the main causes of the 1970s S&L crisis which led to the creation of the RTC. Sure enough, you can rely on Citibank to repeat the mistakes of history with their SIV issuance (selling commercial paper to fund ultra-long CDOs. These cathedrals of finance were designed to reduce their reserve requirements.).

Sorry, I’m straying. Remember, if banks pay 1% on deposits and lend at 5% on mortgages, that is 4 point spread of free money. With mortgage rates at 5%, almost all MBS are premiums (i.e. priced over par). Yes, it sucks when premium investments prepay at par, except when you are worried about getting back any of your principal!

Crabs, On the FN and FH dilemma. Yep, those payouts are what scared me out of nearly all the Agency REITS. If you’re a Chinese bondholder who bought at or below par, then having Fannie and Freddie come clean and make good on all the bad mortgages is great (though you now find yourself holding cash that you’ll have to find someplace to reinvest at a lower rate). But if you bought into these things at above par, and leveraged them up 7 times over, like some of the agency REITS, then an influx of early payouts is a disaster in the making. ANH and CMO don’t think like the Chinese, apparently.

But this only gets at the deeper question, really, of why anyone would be dumb enough to write a mortgage in the first place–absent a secondary market–or to buy an MBS in the secondary market. If you think about it, it’s only based on a collective delusion that any kind of private secondary market for MBS exists. I always think about a mortgage as a severely loaded bet between you and the lender (or MBS buyer) over interest rates. Why would anyone be willing to lend someone $500K at 5% for as much as 30 years, knowing full well that right off the bat inflation is going to eat into a portion of that yield; that the person on the other end of the bet can always get out of it for free (and will almost certainly do so when they’re losing) ; and (what we now know in hindsight) that the fixed interest rate of even the best of these “AAA” securities doesn’t adequately price in either the risk to principal loss or the political uncertainty surrounding the market or the credit worthiness of the “guarantors.” Unless you know that there’s some sucker in a state pension fund, insurance company, Chinese bondholder, or–ahem, cough–the US govt who is willing to take this off your hands the moment the bet goes south, no one–I repeat, no one–would be willing to make this bet at anything even approaching today’s “market” rate for mortgages.

If the US govt wants to keep up this charade of cheap, easy money to fund home purchases, the sad, scary reality is that nearly all of this stuff is going to end up either guaranteed by the US govt or on its actual balance sheets, including some of the worst of what was already done privately.

Save some canned food for me, RW!

Thanks, Geoff

Second, the S&P 500 is going UP in response, not DOWN:

If this is all to be believed, the stock market is anticipating rising rates as a sign of increased economic activity, not armageddon. Perhaps I didn’t need the canned food after all.

The article hints that this whole thing is likely to be purely symbolic, involving only a few thousand token borrowers such that politicians can have political cover of helping homeowners and the unemployed going into elections, which are going to be a bloodbath. Also, banks like BOA get to look contrite and pretend they would actually participate in this for anything other than purely instrumental reasons. But this thing could really take off: imagine I’m a bank on the hook for a crappy, doomed mortgage I was dumb enough to keep on my own books. And the US govt is willing to refi this thing via FHA and take it off of my hands, even for a 25% haircut. Sign me up! Just watch how fast we can fill out the paperwork now.

Perhaps we should start studying Chinese instead.