This week’s attempt by the FDIC (Federal Deposit Insurance Corp.) to sell securities backed by residential mortgages and construction loans marks a huge milestone in the road back to normalcy for the financial markets this week. Let’s hope the markets pass the test.
The FDIC has bundled together some of the mortgages and loans it owns after taking over failed banks into a mortgage-backed security of the kind that was the mainstay of the mortgage market before the financial crisis.
That market has been essentially closed for new business since the crisis with only Fannie Mae (FNM) and Freddie Mac (FRE) willing to buy these securities with funds provided by taxpayers. Banks use this market to sell mortgages that they have originated so they can put the proceeds back into new mortgages. When this market is frozen, banks have to hold onto the mortgages they’ve originated and that reduces the money they have available for new mortgages. If banks know they can’t securitize and sell their mortgages, they become more reluctant to lend. And that reduces the availability of mortgages.
Because private investors haven’t been willing to buy these securities post-crisis, taxpayers through Fannie Mae and Freddie have been left as the only buyers. That’s been necessary to keep the market functioning at all, but Fannie and Freddie can’t keep expanding their books forever. At some point private investors need to step back into this market.
The mortgage-backed securities that the FDIC will offer for sale this week are designed to entice private investors back into the market.
The expected interest rate is 0.9 to 0.95 percentage points above the yield on U.S. Treasuries for the fixed-rate portion of the offering.
But it’s not the interest rate that’s the biggest inducement. This offering—the first is for $1.8 billion-comes with a government guarantee. The hope is that will be enough to get private investors to buy.
Of course, if the deal sells taxpayers won’t really be off the hook. The mortgages and loans will be off taxpayers’ books at the FDIC. But the securities will still be backed by taxpayers.  It’s taxpayer money, after all, that stands behind the guarantee.
So call this a half step back to normalcy for the mortgage-backed securities market.
But remember that the 10,000 mile journey to normalcy begins with a half step.
If, that is, the offering sells.
I think a REIT like NLY or CIM would definitely be the way to go. These REIT’s have the benefit of being able to buy more of these junk MBS and CMBS for cents on the dollar if things get worse and the underlying mortgages become more secure if things get better. MBS and CMBS aren’t bad investments as long as the price is right.
Any premium over Treasuries is just our government using tax payer dollars to pay someone to take this junk off their books. That way they can keep pumping out false statistics that can be spun to look like our recovery is continuing.