When the Federal Reserve began buying agency mortgage-backed securities (MBS) last week, the central bank dropped $183 billion on the industry in an effort to lower mortgage lending rates. Those purchases have worked as expected, but with one unintended side effect.
In a letter to the U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA), the CEO of the Mortgage Bankers Association (MBA) noted that “dramatic price volatility in the market for agency mortgage-backed securities (MBS) over the past week is leading to broker-dealer margin calls on mortgage lenders’ hedge positions that are unsustainable for many such lenders.”
The threat is the result of mortgage lenders hedging their pipeline of new loan originations by taking short positions in the MBS market to protect against a drop in value of the securities before they begin to be sold in the secondary market.
As MBA CEO Robert Broeksmit elaborated:
The lender has a natural long position in the mortgages in its pipeline, and a short TBA position allows for an offset in the effects of interest rate movements. When interest rates rise, the lender will suffer losses in the valuation of its pipeline, but it will gain on its hedge – and vice versa when interest rates fall. Lenders most frequently engage in these transactions with broker-dealers that are regulated and supervised by FINRA and the SEC.
In periods of high volatility (now, for instance), adjustments in hedging positions include margin calls on mortgage lenders that “reached staggering and unprecedented levels by the end of the past week.” The sudden, large calls on lenders’ cash “are eroding their working capital and threatening their ability to continue to operate.”
Without spelling out a specific solution, Broeksmit wants the SEC and FINRA to be more flexible in how broker-dealer hedging practices are treated. He says only that margin calls on the hedges “should not be escalated to destabilizing levels” and asks the two regulating agencies to “issue guidance” making that policy clear. Without such guidance, “the U.S. housing market is in danger of large-scale disruption.”
The nub of the problem is that MBS purchasers want their cash as the economic slowdown threatens liquidity. But if everyone demands cash immediately, something has to give. It resembles big-money musical chairs. No one wants to be left behind when the music is still playing, and for sure no one wants to be left looking for a seat when the music stops.
Get Ready To Retire (Sponsored)
Start by taking a quick retirement quiz from SmartAsset that will match you with up to 3 financial advisors that serve your area and beyond in 5 minutes, or less.
Each advisor has been vetted by SmartAsset and is held to a fiduciary standard to act in your best interests.
Here’s how it works:
1. Answer SmartAsset advisor match quiz
2. Review your pre-screened matches at your leisure. Check out the advisors’ profiles.
3. Speak with advisors at no cost to you. Have an introductory call on the phone or introduction in person and choose whom to work with in the future
Get started right here.
Thank you for reading! Have some feedback for us?
Contact the 24/7 Wall St. editorial team.
Latest from 24/7
