THE MORTGAGE MARKET

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THE MORTGAGE MARKET: NEW POLICY
 Obama Administration announced on Friday another attempt to prevent an
overflow of foreclosures
 Previous efforts to prevent foreclosures have been failures, for the most, part
because the incentives haven't been strong enough to get lenders to go along
 The new plan increases the amount of money going to banks and other
lenders if they'll write down the principal of the loan
 In most cases, the government's programs have merely postponed the
inevitable, allowing borrowers who can't afford their mortgage payments to
keep paying for a few months longer (so far, only about 200,000 mortgages
have been permanently modified into affordable home loans)
 That is only a minor fix; it's expected that as many as 13 million
homeowners will lose their homes to foreclosure in the next five years,
according to a congressional oversight panel, meaning more bank write-
downs and a greater likelihood of a downturn in the mortgage market

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THE MORTGAGE MARKET: PAST WEEK
 Selling this week and weaker demand in the Treasury's debt sales,
worth $118 billion, were largely due to worries over the U.S.'s large
fiscal deficits
 The selling pushed up yields, which move inversely to prices, with the
10-year yield on Thursday touching the highest level since June 2009
 The increase in Treasury yields has pushed up mortgage rates this
week, raising concern that, if yields continue to rise, it would
undermine recovery in the U.S. housing market
 If this scenario plays out, the outlook for the broader economy looks
bleak as markets are still relying on heavy fiscal and monetary
stimulus to recuperate from the downturn

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THE MORTGAGE MARKET: PAST WEEK
 Going forward, there looks to be a rise in selling from mortgage-bond
investors looking to hedge their portfolios as the Federal Reserve’s $1.25
trillion MBS purchase program ends
 The negative risk premiums in the interest rate swaps market, another factor
behind the Treasury selloff this week, could also weigh on the U.S.
government debt market, especially long-dated maturities
 Many short-term investors including hedge funds were caught off guard
when long-term risk premiums in the swaps market—where investors
exchange fixed for floating-rate interest payments—turned negative this
week
 This forced selling of Treasuries, adding to the push higher in yields

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THE MORTGAGE MARKET: QUANTITATIVE
EASING ENDS
 The FED has been buying up Mortgage Backed Securities since the
beginning of January 2009
 In total, it has transferred $1.25 trillion of MBS "on behalf" of the US
taxpayer, representing the single biggest asset on the Fed's balance sheet
 These MBS are backing up such liabilities as currency in circulation and
excess reserves, meaning the USD is collateralized more than half by
rapidly devaluing, and in many cases cash flow non-producing houses
 This Quantitative Easing is set to end tomorrow, April 1, 2010
 When the program ends, the mortgage market will be on its own for the
first time in over one year

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THE MORTGAGE MARKET: QUANTITATIVE
EASING ENDS
 As a result, there is a chance liquidity, mainly in MBS, will
decrease dramatically adding to concerns of increases in
mortgage rates and, consequently, a second fallout in housing
 MBS are already looking overvalued no matter what metric
you are use
 That's also without considering the Federal Reserve no longer
buying agency MBS or questions about asset sales down the
road
 It looks to be a challenging environment for mortgage-backed
over the next couple of quarters

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THE MORTGAGE MARKET: QUANTITATIVE
EASING ENDS
 And, as Flanagan noted, the "U.S. fundamentals are not
too supportive, given the unsustainable fiscal deficits,
higher debt burdens, record coupon supply this year and
the economic recovery.” 
 That said, not only is he concerned about their valuation,
but also about the impact of the rising Treasury yields on
the MBS market, as he expects the 10-year Treasury yield
to rise to at least 4.50% this year 

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THE MORTGAGE MARKET: POSITIVES
 1) Fast and real money accounts are known to be very short the MBS
market. Some have already covered recently as option adjusted spreads
have widened. Others will wait for widening in nominal spreads. How
long they will wait is a big unknown
 2) The recent backup in Treasury prices caused foreign investors to
have renewed interest in the market, particularly for Ginnie Mae paper
(MBS)  A further drop in dollar prices could encourage other investors
to come back into market
 3) Banks have been supporting the market for a while now and, with
short-term interest rates low, they are expected to continue to pursue the
carry trade. As long as the Fed's low interest rate policy stays in effect
for an extended period, this is widely fostered investment strategy-
meaning investors are short USD

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THE MORTGAGE MARKET: POSITIVES
 4) Freddie Mac already finished its delinquent loan buyback program. But Fannie
Mae's buybacks take place over the next several months and are likely to amount
to about $150 billion. Surely some of this money will be reinvested in MBS
 5) The housing market still shows no signs of a turnaround and credit is still very
tight. This should keep new origination supply very manageable in the absence of
the Fed buying. If and when it ever picks up again, it is hoped the MBS market
will have its sea legs back on
 6) The Fed has been buying all the lowest coupons around, the coupons no one
wanted. But The GSE’s buybacks and the ongoing changes to the government's
Home Affordable Modification Program (HAMP) have recently wreaked havoc
with the higher coupons. Consequently, that is pushing some investors into the
lower coupons
 7) Finally, the market strongly believes if the housing and/or the mortgage
markets got in severe trouble, the Fed would have no choice but to begin buying
assets again

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THE MORTGAGE MARKET: NEGATIVES
 1) When everyone is on the same side of the boat, it often ends up badly. In
other words, the idea that the investment community is heavily short does
not guarantee success
 2) Even with a short investor base, the market still lacks a "backstop" bid
like it used to have in the old days when the GSEs would buy MBS when
they widened out to attractive levels. Without the Fed, and with the GSEs
crimped, who will become the new backstop bid
 3) It may not happen for a very long time, but eventually the economy will
recover and the Fed will raise rates. Over time, 10-year note yields are
expected to rise. If that is the case, why buy any fixed income product now
 4) How high 10-year rates get down the road is anyone's guess. But market
sources say the end of the Fed MBS buying, heavy Treasury supply and the
potential of a boycott by overseas investors in the Treasury market could
send yields from the current 3.87% to 4.25% or even 5.25% over time

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THE MORTGAGE MARKET: NEGATIVES
 5) It is highly doubtful that the Fed will sell any of its huge MBS holdings for a very
long time. But the possibility is there and it has made the market very nervous, and
market uncertainty leads to risk-adverse investments
 6) Before the Fed sells assets, it would likely do reverse repurchase operations with
its MBS holdings. Market sources say that will most surely raise the cost of carrying
MBS securities
 7) Because the Fed was such a large buyer of MBS and it did not hedge its positions,
hedging convexity has not been something the market has worried about for well
over one year. But now that the Fed is no longer buying, the new duration that comes
into market will have to be hedged. Indeed, part of last week's selloff was blamed on
convexity selling
 With the Fed having gone all in and then reraised tenfold courtesy of fractional
reserve banking, there is no way that the Fed will allow house prices to drop further,
which is why we are particularly partial to the option that the Fed will immediately
reinstitute QE at the first hint of mortgages at or approaching 6%, as a 1% widening
in mortgage rates will be the equivalents of a several hundred billion loss in
household net worth. And the administration can not have that in an election year
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THE MORTGAGE MARKET: TIMING

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THE MORTGAGE MARKET: TIMING

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THE MORTGAGE MARKET: TIMING

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THE MORTGAGE MARKET: SUMMARY
 Government is delaying the inevitable: individuals cannot afford
their homes and more write downs are due
 Mortgages are overvalued across the board
 Now the largest buyer of mortgage-backed securities, the FED, is
pulling out; the liquidity fueled rally will end
 The US fundamentals are not supportive; fiscal deficit and rising
treasury rates look to undermine the housing recovery in the long run
 The acceleration chart of housing prices shows we are at a tipping
point
 A breakdown is due so we have placed a short position on US real
estate
 Bought SRS: ProShares UltraShort Real Estate

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THE MORTGAGE MARKET: IYR
US Real Estate (IYR) vs. S&P

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THE MORTGAGE MARKET: SRS
SRS: Proshares UltraShort Real Estate 2yr

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THE MORTGAGE MARKET: REFERENCES
 http://www.marketwatch.com/story/another-doomed-plan-
to-prevent-foreclosures-2010-03-26
 http://www.zerohedge.com/article/january-fannie-mae-del
inquency-rate-climbs-new-record-552-14-bps-higher-janu
ary-double-year-
 http://www.zerohedge.com/article/24-hours-until-end-mbs
-purchases-fed-then-what

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