Mortgage QE?

Posted by on Dec 2, 2011 in Uncategorized | No Comments

There has been more and more speculation that the Fed is getting ready to launch a new QE program, this one targeting residential mortgages. With the data coming in better than expected, stocks back up, and Plosser and Bullard both chiming in that improving data would make them hesitate or question the need for more QE, there is some fear that it is off the table.

I don’t think it is off the table, and if anything see growing signs that they are trying to create the political will to get it done. Obviously some Fed members have been vocal about doing more, so the dissenters do have competition. Some of the usual “leak” sources have been indicating that it is possible, but that is not what got me more curious.

Today at least 5 commentators on Bloomberg were downplaying good data and stating that things can’t get much better without housing. I agree, but it seemed like a weird day for so many people to refer to housing. There was no housing data out today, and the jobs report was okay so it wasn’t obvious to point out the continued weakness in housing. Maybe after weeks of Europe and deficit talks, it was time for a new subject, but it just struck me as odd how often it came up. 2008 was easier, back before Bill Gross fell out of favor with the White House, because you knew whatever he said was an attempt to prepare people for a new policy. It is harder now to figure out who is setting the market up, but I find it hard to believe that it is a co-incident that “the need to fix housing” was on everyone’s lips.

So I think Bernanke is trying to lay the groundwork of why it is so important to buy mortgages.

Politically Unpopular 

There is a strong belief that more QE is politically unpopular. That is true but it also makes sense that the Fed would push more people into talking about how the key to real recovery is the housing market. I am also reasonably sure that Bernanke will do what he wants if he believes it is the difference between turning the corner into real recovery or risk slipping back into daily double dip talk. My guess is the job is less fun than he thought, but he has gone so far, he is not going to be scared by politicians (who have proven their ineptitude) from doing something he believes strongly in. Even if he backs down from full on QE, maybe operation twist can be twisted to purchase mortgages rather than treasuries? Clearly the transfer mechanism from 10-year bond yields into cheap mortgages for everyone is broken. He is creative and seems to get what he wants, so I wouldn’t place too much faith in political will stopping him. Maybe it should, and maybe the Fed needs more accountability and some strict limits beyond which he needs Congressional approval, but for now I think he can do what he wants to a large degree. That scares me, but doesn’t seem to bother him.

The politicians might be against QE, but many citizens would be less offended by the Fed buying US residential mortgages than they are by the Fed offering global swap lines (and even that didn’t seem to generate public outrage). The one asset class that the Fed could buy and make citizens happy is mortgages – especially if it helps create new origination.

Mortgages – Liquidity Or Solvency Problem?

I think residential mortgages are now much more of a liquidity problem than a solvency problem. GNMA vs FNMA spreads hit a recent record wide. Many investors seem to be interested in residential mortgages but are waiting for prices to come to them. European banks, who will continue to shed assets in the US do have lots of RMBS paper, they could use a nice aggressive bid.

So the current mortgage market has many of the same characteristics that made QE1 so successful (I liked QE1 but hated QE2 and don’t like Operation Twist). There is a pool of potential investors who won’t buy because they think it is getting cheaper. There is a group of quasi-forced sellers. They need to shrink balance sheet and this area is an obvious choice as the losses are in the manageable range and some banks may even be almost properly reserved against the losses. There is no natural buyer. US banks, in spite of a massive rally this week in CDS spreads, still see their bonds lagging (another liquidity problem?) and aren’t aggressively adding risk. If the Fed comes into this market it could make a difference. It puts a floor on the market, as it chases prices up, and European banks have less to sell than is feared, then private investors may chase the market. Investors are talking about 12-14% loss adjusted yields in the sector. It wouldn’t take much to spur them to action. Heck, you can almost hear the ETF guys cranking out some new ETF’s so retail investors can jump on the bandwagon. If the Fed can use their balance sheet to spur private capital to work, that makes sense.

If US banks get comfortable there is a buyer of mortgage paper, they can maybe be a bit more aggressive on generating new mortgages. They are concerned about the solvency of each individual mortgage, and that has made them possibly too conservative. Freeing up some balance sheet, seeing hedge funds buying up secondary market product, may generate the kick in the behind, that they need. Operation Twist was too smart for its own good. This is simple and direct and could be politically popular in the end. Personally I don’t love the idea, but it makes more sense than many other proposals out there to improve the situation, and it helps deal with the European bank liquidity problems in a way that is less obvious than lending them money.

How Likely?

I’m guessing it is about 75% likely we get something relatively soon. I prefer changing Operation Twist to buy mortgages rather than outright purchases, but maybe we need another dose of dollar weakness (or it would offset the dollar strength we might see if Draghi turns his printing presses up a notch or two).

I think Draghi is 100% likely to cut rates, probably the day after we get another hand holding moment stating that some agreement in principle has been reached on treaty changes. I think he is only about 50% likely to start printing, but the sterilization is getting more difficult to manage and frankly may be draining liquidity from other parts of the system that could use it. If they start printing, I’m not sure that it can end. Their situation is much more complex than ours. We are playing with some scenarios, but most end up with a realistic chance that more debt of each country and more countries need to get monetized. Weird, and maybe there is a way to stop printing and not go right back to bigger problems, but it isn’t obvious to us.

I think there is about a 25% chance that the EFSF raises a slug of money next week, so it can join in the party. The 275 billion euro doesn’t fix anything on its own, but maybe it is time to get started. Get 25 billion or so to work in the primary and secondary market and spend less time have intellectual debates on the best way to leverage (without any structured credit intellectuals even involved). They should do something like this, but given how disorganized they are on EFSF, I doubt anything happens.

Who knows what the IMF will do, but I suspect they are ready with some positive announcement after the photo op treaty agreement announcement (the treaty won’t ever get changed but no one will care for a week or so).

A group of conservatives is out there trying to stop the IMF. I don’t understand why the IMF is so big or has so much of our money at our disposal, but I find it hard to believe that we won’t need to pass something to stop money from going to them under prior commitments and Congress passing anything is hard to imagine right now.

In any case, it should be another fun-filled week. At some point i would love to find out if the swap line cut and China rate cut were coordinated or just happened. I think it may have been dumb luck but the central bankers are now clearly aware how much markets liked the idea and will use it again to get cheap thrills.