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Mortgage Bonds Boosted by Weak Housing Market

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Tom Grill | Photographer's Choice RF | Getty Images

This is truly perverse.

One unintended consequence of the government's takeover of housing financing is apparently a breakdown of the alliance of interests between homeowners and the holders of mortgage-backed securities.

Homeowners, of course, want their home values to appreciate. And, back when there was a substantial amount of private label securitization that lacked government backing, so did investors in mortgage backed securities. Rising home prices cut down on default risk and increased recoveries during foreclosure.

But government backing changes this calculation. The investors in mortgage bonds no longer bear the default risk because the bonds are insured by taxpayers. So the big risk, especially in a low interest rate environment, is refinancing risk. And a soft housing market with lots of delinquencies makes refinancing difficult.

HousingWire's Jacob Gaffney picks up on a Deutsche Bank note explaining the dynamic:

However the new plan will lead the U.S. into further austerity, with more cuts to federal spending, in a development that is likely to suit the mortgage-backed securities market well, according to Deutsche Bank (securities analyst Steven Abrahams).

"The solution this week to U.S. debt and deficit problems may help MBS by keeping selected housing markets soft and delinquency rates high — both significant impairments to borrowers’ ability to refinance," he said in a note Wednesday to clients.

"And as the last few years have shown, soft housing markets significantly dampen agency MBS prepayment risk," Abrahams said, adding that most of the volatility due to the lingering threat of downgrade appears priced in to the secondary market.

The housing market, of course, is a significant drag on the broader economy. It's not good to have financial institutions whose interests lie in the opposite direction of a recovery.

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