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Monday, November 23, 2009

Agency Mortgage Bonds are RICH

Bloomberg (via Calculated Risk) details Meredith Whitney's latest concern:

The Federal Reserve has begun slowing purchases in the $5 trillion market for so-called agency mortgage-backed securities after announcing in September that it would extend the timeline for its $1.25 trillion program to March 31 from year-end. Whitney said that banks are only originating home loans that they can sell to Fannie Mae and Freddie Mac.

“If Fannie and Freddie can’t sell to an end buyer, i.e. the U.S. government steps back, the mortgage market at minimum contracts, rates go higher, and banks are poised with more writedowns,” said Whitney, founder of Meredith Whitney Advisory Group. “This is probably the issue that scares me most across the board.”

The chart below shows the option adjust spread "OAS" of Agency Mortgages to Treasuries. This is model driven (the below utilizes Barclays model) to estimate for pre-payments by borrowers and a number of alternative models suggest the OAS is now NEGATIVE to Treasuries (the power of subsidies!).



The question is who is buying mortgages at these levels besides the Fed? Easy... any investor in the Barclays Aggregate index (think pension plans, 401k participants, etc...) .

Source: Barclays Capital