Treasury's Mortgage Debt Sale Comes at Tough Time for Housing

The Treasury Department’s move to start unloading its portfolio of mortgage debt likely will add one more point of pressure—albeit a small one—to a housing market hardly in a position for additional stress.

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Later this month the government plans to shed about $10 billion in its $142 billion portfolio of mortgage-backed securities that were guaranteed by government-sponsored enterprises Fannie Mae and Freddie Mac. The sales then will happen incrementally over the next year or so.

In the broader scope of things, the new supply is a brief shower inside a typhoon of debt that the Treasury and, to a far greater extent, the Federal Reserve—which owns $1.25 billion in MBS—took off the GSE balance sheets during the worst of the credit crisis.

But it represents the first move to send the debt back to the open marketplace where it belongs, even if it pushes artificially low rates higher. The law of supply and demand would indicate that with a greater level of product out there, the holders will have to start paying bigger returns to attract buyers.

The escalation in mortgage rates likely will only be a question of degree, which in turn will be determined by how anxious investors are to start buying debt that only two or three years ago was so toxic it brought down the world’s biggest financial system.

How the initial sale turns out will be a key indicator for Treasury Secretary Timothy Geithner as he tries to restore the debt markets back to normal.

“To the extent that there’s a market for anything, there is” a market for the MBS about to be sold, says bond trader Kevin Ferry, president of Cronus Futures Management in Chicago. “What you’re seeing is a series of very incremental, very Geithneresque steps towards what is the exit strategy.”

Treasury officials don’t anticipate any adverse reaction to the housing market, though most analysts expect at least some upward pressure on mortgage rates.

“The question is, who is going be their buyers? Obviously it’s going to be major funds. But are they willing to take the paper at this time or are they willing to gamble in terms of returns?” says Peter Cardillo, chief economist at Avalon Partners in New York. “That’s the major question overhanging the market. They’re going to have a hard time unloading this without moving rates higher.”

Treasurys’ timing couldn’t have been much worse, considering housing numbers Monday that showed a sharp drop both in price and sales.

In its statement announcing the sale, Treasury contends that the purchases were done to stabilize the market. Critics argue, though, that the prolonged intervention only hampered the housing market recovery while bailing out too-big-to-fail institutions that caused the problem.

Ferry also questioned why the Fed is maintaining its zero-interest-rate policy on the funds rate even as it is allowing banks to increase dividends and recapitalize while also unloading the MBS.

“It just shows that banks still have an inordinate amount of power in the process of how things are going down,” he said.

Still, he expects the Fed do have a fairly efficient go of it when selling the MBS.

“There are going to be days when I think it will be a little sketchy,” he said. “I think they’ll get it done, no problem.”


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