|Fannie Mae current coupon minus 10-year US Treasury note
|Purchasing power of a $1,000 payment at various interest rates
|Mortgage debt outstanding (source)
|The "primary-secondary" spread, the difference between the
yield borrowers pay, and what MBS yield.
Additionally,there is evidence to doubt whether lower MBS spreads will be passed on to customers or whether the banks will keep the windfall. Despite current coupons trading at record tight spreads, the "primary-secondary" spread remains, not only stubbornly high, but near all-time record highs! (see lower left). Proponents of the MBS Twist insist that the Fed can put pressure on the "primary-secondary" spread and push savings to borrowers by increasing (more in a second) their purchases of current coupons, but to me it is clear that the problem lies in the demand, not supply, side of loans. This is why, unless we see further expansion of H.A.R.P. (Home Affordable Refinance Program) which increases the pool of homeowners eligible for refinance, I think the ultimate effect of an "MBS Twist" on aggregate demand will be limited and the ultimate economic beneficiaries will be banks and security holders who see their securities increase in price.
That being said, I want to make it clear that I believe there is a very high probability of an "MBS Twist." I believe that with inflation declining, unemployment stubbornly high and total gridlock by the pathetic cowards and liars that make-up the legislative branch, Chairman Bernanke will continue to lead the effort to maintain the recovery on-track with the tools available to the Federal Reserve, limited as they may be. And judging by the first chart in this post, I am not the only one to think so. One of the reasons that I find the "MBS Twist" or a new round of MBS LSAPs as the most probable form of additional easing is that the Fed is already doing the MBS twist. Every month the Fed receives cash-flow representing interest and principal on their approx $530 billion in Fannie Mae 4.5-5.5% pools from the first round of LSAPs. The portion of that cash-flow representing principal repayments is reinvested into current coupon MBS in order to maintain the size of the Fed's balance sheet. In other words, every month, the portion of the Fed's MBS portfolio held in the new Fannie Mae 3s increases. The fact that this is something that is already happening makes me think that simply speeding up this process would be a natural extension of present policy.