Replies to post #25713 on FinancialAdvisor's College Class (FACC)

[FinancialAdvisor]

Fannie Mortgage Bond Spreads Shrink to Record

Mar 9 2010, 1:30 PM ET

Fannie Mae and Freddie Mac's mortgage-backed securities are trading at yields that are the closest ever to Treasury bonds, reports Bloomberg. That means investors are differentiating less between these agency mortgage bonds and Treasuries. And that makes sense.

Bloomberg explains:

The difference between yields on Washington-based Fannie 
  Mae's current-coupon 30-year fixed-rate mortgage bonds and 10- 
  year Treasuries was unchanged today at 0.63 percentage point, 
  matching the smallest spread since at least 1984, according to  
 data compiled by Bloomberg.

To the naïve observer, this might be surprising. Shouldn't investors be shunning anything related to mortgages and the agencies? The mortgage market has been a disaster over the past few years. Fannie and Freddie collapsed and had to be rescued by Uncle Sam to the tune of untold billions of dollars.

But therein lies one reason why the spread between the yields on agency mortgage bonds and Treasuries has shrunk to near nothing: Fannie and Freddie are essentially owned by the U.S. government. Investors now see little difference between the credit quality of agency issued debt and that the government directly issues. After all, the government is on the hook for those bonds as well now, more explicitly than before. The only characteristics investors really need to worry about with agency mortgage bonds at this time are prepayment risk and structural differences.

That prepayment risk is also seen as minor currently. Rates are currently quite low, so the prospect of many borrowers refinancing to achieve lower rates than what they're getting now isn't very likely.

This news is both good and bad. If you're someone who hopes to obtain a so-called conforming mortgage -- one that adheres to the agencies' criteria of what they can purchase or guarantee -- then this should keep your rates relatively low. As long as Fannie and Freddie can continue to provide liquidity, those mortgages won't be too hard to get. Of course, that's of no help to anyone who wouldn't qualify for a conforming mortgage: the non-agency mortgage-backed security market remains closed.

Anyone who hates Fannie and Freddie also has reason for disappointment. The success of these bond sales means that Fannie and Freddie continue to thrive on government life support and grow in size. The more investor appetite that exists for their bonds, the more mortgages Fannie and Freddie can guarantee or purchase. If you wanted to see the agencies' role in the housing market decline, then you probably aren't thrilled that they're still getting funded so easily. But that's mostly thanks to having the U.S. government standing behind their obligations.


LINK: http://www.theatlantic.com/business/archive/2010/03/fannie-mortgage-bond-spreads-shrink-to-record/37237/