The Big One (in mortgages)

Will the Fed’s MBS bond investment program ever unwind, and when? This is the $1.75 trillion question that people are starting to ask. If it does unwind, everything old might be new again.

The Fed purchases almost $400 billion MBS annually, and owns one third of the market. Moody’s sees the possibility of 6 percent mortgages. If the economy strengthens, it is easy to imagine 10 year treasuries widening 100 bps. If the Fed MBS program goes into reverse, it is easy to see mortgage spreads widening by another 100-200 bps.

The market has had a pleasant holiday from thinking about control, work-out, and documentation issues with respect to new MBS for the last couple of years. But a world where yields spike is a world where homeowners face higher costs of financing, where home prices drop, where defaults increase, and where deal protections begin to matter again.

Keep your DealVector Deal Center’s current in MBS. It may be the cheapest hedge against the tail risk of a mortgage earthquake.