Earlier today we noted that the biggest buzz on Wall Street is the recent suggestion by MS and ML's Harley Bassman that the GSEs should provide some form of autorefi program to take borrowers to market rates. As this would impact a vast majority of the 37 million of mortgages outstanding backed by the government, not only would this housing stimulus have a huge impact on consumption appetites, but it would be a political coup as all of a sudden the administration would find tens of millions of giddy homeowners who are paying far less monthly, and quite satisfied with the way Obama has handled things. It is thus likely that this program will take off shortly (if at all) just before the mid-term elections to neutralize all the pent up discontent focused on the administration. Yet there may be less than meets the eye. As Market News points out, over the past 24 hours Wall Street has gone into overdrive analzying the consequences, both positive and negative, of such a move. Below are the conclusions.
First, here is how the pricing action in various MBS tranches occurred:
Premium MBS bonds went down in price because this refi concept stoked speculation that primary mortgages with higher rates will get paid off soon and the higher coupon MBS that backed those mortgages would be called back. This paper would be replaced with lower coupon MBS that would then be backing primary mortgages at lower rates.
And here is the prevailing Wall Street sentiment on what seems quite certain to become the Treasury's latest stimulus:
Many mortgage analysts said the concept sounded good but there would be many hurdles to cross before this could get done.
Still, mortgage strategists at Credit Suisse said the idea is "appealing in principal" but there are many barriers. Some of these are:
1) Program would have to be structured as a refinance not a modification because the former costs investors and the latter costs Fannie, Freddie and Ginnie;
2) Eligibility decisions would have to be simple to execute "en masse" and in some cases government might be "over-subsidizing;"
3) In order to use the current system, the housing agencies would have to "indemnify" lenders against put backs;
4) Refi costs would have to be rolled to get around borrower cash constraints;
5) Might have to be origination fees and loan level pricing adjustments (LLPAs) would have to be dropped, reduced or rolled in;
6) Agencies might end up charging higher guarantee fees to compensate for higher Loan-to-Value or LTV;
7) Assuming all borrowers with 6% or higher mortgage and current LTV>80% from '05-08 are refied might create $750 billion in lower coupons and Fed's balance sheet might have to called upon again, with likely opposition in Washington;
8) MBS market would be disrupted again as tradeable float taken from market;
9) It could take 6-9 months to process the loans. They estimate $10-15 billion in incremental annual savings for homeowners, much less than other estimates in Street.
Citigroup mortgage strategists said the chance of this program coming to fruition was "remote" and highlighted the costs.
Citi says a program that would refinance all GSE loans with a 5.75% or higher coupon into a 4.50% coupon could provide about $30 billion in stimulus from consumers.
But It would also cause a $30 billion premium loss to the GSEs retained portfolio, raise Treasury borrowing costs by $5-10 billion ayear as yields rose, and mortgage rates might rise by 100 bps.
Citi says the rise in mortgage rates would be due to higher Treasury yields, higher negative convexity, higher implied volatility and massive gross issuance which would be a significant short-term problem.
The "free lunch" refi programs that some are advocating "are actually very expensive and would result in more indigestion than thegovernment can stand," the Citi said in a research report.
They also reminded that 90% of the loans that would be allowed to refinance are not delinquent loans. Delinquent loans are getting betterand more appropriate help from other government programs.
Mortgage strategists at Nomura Securities said the odds of such a plan are only 10% if there is no double dip in the economy. If there isa double dip, the odds rise to about 30%.
If the plan was adopted, most mortgage investors would suffer "meaningful" losses in the short-term.
However, the $1.3 trillion in mortgage securities owned by Treasury and the Federal Reserve would suffer less because their costs are lower, they are not marked to market and any losses would be offset by the interest the government has already received, Nomura said.
But Nomura also pointed out that if such a plan was instituted because of a double dip in the economy, the effect on bond yields and mortgage spreads would likely be reduced.
And the government might convince originators to reduce primary/secondary spreads to more normal levels.
Because of these factors, Nomura thinks primary mortgage rates would only rise to 5.00-5.25% which is still attractive.
Finally, Nomura says mortgage investors might complain about government interference in private affairs, but the government could make a few good arguments of its own.
For example, where would the markets be now if the Treasury and Fed had not bought $1.3 trillion MBS foster lower mortgage rates.
And the government would indeed be helping people who are not delinquent and are still making their mortgage payments at much higher than current market rates.
That might sound like a pretty admirable plan if a double dip ensues.