Thursday, May 05, 2016 11:34:44 AM
Fannie Mae has assets. These are the mortgages on homes that others originate and they purchase. These are like promissory notes to pay interest and principle over time. These assets are not inherently interest rate sensitive.
Then Fannie has two classes of liabilities. They have the risk of a consumer's failure to pay their promised P&I. This, too,is not interest rate sensitive; the amount owed Fannie is not variable. It is what it is.
So why are interest rates so important to them? Well, in a default, the ability to foreclose and resell underlying collateral for the mortgage asset becomes more difficult in a higher rate environment, but then eventually gets offset when the new mortgage originated to replace the foreclosure is issued at a correspondingly higher rate of interest. In the end, no long term impact.
But, wait, there's another class of liabilities lurking on the books. That's the MBS bonds Fannie has issued whose rates (payouts to bond buying customers) are pegged to the prime rate, Treasuries, or now even LIBOR in the case of new Freddie STACR DNA-series bonds. The amount paid out varies when indexed against some external benchmark.
So what would be simple? What would work better better?
1. No more hedging and derivatives.
2. Privately insure collateralized assets (not the mortgages). This reduces mark to market exposure. The Fairholme proposal is, I believe, still on the table to do this.
3. Structure all future MBS bonds on a non-indexed basis. This is commonplace on corporate bond structure. And, yes, this will raise coupon rates substantially, but not pre-emptively.
4. In this revised structured, government could offer a low cost backstop to the GSEs under extreme circumstances so it would offset the higher costs of indexed bonds.
JMHO.
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