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Monday, April 12, 2010

PIMCO's Simon on a Post-Fed MBS Market

by Calculated Risk on 4/12/2010 02:34:00 PM

Scott Simon, Managing Director at PIMCO Discusses a Post-Fed Mortgage-Backed Securities Market. A few excerpts:

We are unlikely to see a significant market disruption in the Agency market stemming from the Fed’s retreat. ... if and when we see mortgages cheapen, we expect to see private institutions stepping in to buy. Even a 15 basis point move could spark a flurry of buying. Therefore, we don’t expect a major widening of mortgage spreads ...
And some Q&A:
Q: Could you elaborate more on who will fill the purchasing gap left by the Fed’s exit?

Simon: Money managers and other institutions have been sitting on the sidelines for quite a while, but cash yields are essentially zero, making it very tempting to move out the risk and duration spectrum. This is exactly what the Fed has meant to do with a fed funds rate near zero – make it so that investors can’t stand to be in cash any more. For banks, it makes the spread between cash and Agency mortgages look more attractive, and for investors, it makes risk-adjusted yields on Agencies look competitive.
Q: Do you think it’s at all likely the Federal Reserve will reboot its MBS purchase program later this year or in 2011?

Simon: Probably not. Barring a major double dip in the economy or housing, private balance sheets have plenty of room to add Agency MBS (unlike in late 2008, when the Fed program began).
And finally on housing:
Q: Finally, let’s discuss housing more directly. When might we see a recovery?

Simon: We continue to believe that lower-priced homes bottomed last year. Higher-priced homes should bottom later this year. If one labels recovery as prices rising dramatically, we do not foresee that anytime soon.

Q: Do you think the government is done tinkering with housing sales and foreclosures?

Simon: The three issues that need addressing are: 1) negative equity, 2) unemployment and 3) second liens hindering loan modifications. Obama’s plan addresses these issues, but the devil is in the details. ...
My comments: In the low price / high foreclosure bubble areas, I think house prices bottomed over a year ago because of the flood of foreclosure sales (Tom Lawler's "destickification"), however I think there will be further price declines in the mid-to-high end bubbles areas. This is where many of the next wave of distressed sales will be concentrated. My guess is this will push the national price indexes (Case-Shiller, LoanPerformance) to new lows later this year and probably into 2011. And then any recovery in prices will be very slow because distressed sales will remain elevated for some time.

And 2nd liens remain a huge stumbling block. Dakin Campbell and David Henry at Bloomberg had a story on 2nd liens and banks this morning: Bank Profits Dimmed by Prospect of Home-Equity Losses (ht Brian, Mike in Long Island, Clip)
Bank of America Corp., JPMorgan Chase & Co. and Wells Fargo & Co. may have to set aside an additional $30 billion to cover possible losses on home-equity loans, an amount almost equal to analysts’ estimates of profit at the three banks this year.

The cost of these reserves was calculated by CreditSights Inc., a New York-based research firm whose prediction almost four years ago proved prescient after banks reported unprecedented mortgage-related writedowns. Recognizing the home- equity loan losses is unfinished business from the housing bubble ...

The four biggest U.S. banks by assets -- Bank of America, JPMorgan, Citigroup Inc. and Wells Fargo -- hold about 42 percent, or $442 billion of the $1.1 trillion in second-lien mortgage loans, according to Amherst Securities Group LP, an Austin, Texas-based firm that analyzes home-loan assets.
Although the article is focused on write-downs for the banks, this also has implications for the housing market.