The Feds will Soon Remove Key Backstops that
Saved the Banks...and They're doing it Too Soon
This is it ladies and gentlemen…the moment of truth.
We’re now swiftly approaching the end of March… and the Fed is out of funds for its "quantitative easing" program, which mostly involved buying mortgages to prop up the housing market.
In other words, they’ve been shooting at this bogey for more than a year, and the chamber is empty. So what’s next?
How much capital has the Fed tied up on their balance sheet to keep your home’s value propped up?
The Fed has completed $1.22 trillion of its $1.25 trillion MBS (Mortgage-backed security) debt purchase program as of two weeks ago. So they’re 98% of the way done propping up housing prices.
How has that helped the value of your home?
Individual results may vary, but with the increasing number of homeowners still underwater… it’s not working out that well, with moderate declines in housing in the past year, and a few brief blips of improvement.
The End of Quantitative Easing;
the Beginning of a Texas-Style Showdown…
The valuation of real estate ties into the Texas ratio: the key component is the value of nonperforming loans. When those start getting written down en masse, Texas ratios will skyrocket.
In other words, right now the Texas ratio is being kept artificially low, giving an extra margin of safety when we enter short positions on the banks (as a higher ratio is a bad thing for banks, and the ratio should, by and large, be higher for most banks that haven’t adjusted the value of their loans to reality).
On the plus side, there are few subprime mortgages remaining to reset…
Subprime Resets over and Done…But they Weren’t Alone…
As you may already know, a “Reset” occurs when the introductory teaser rate on a mortgage is raised to meet the prevailing interest rates of the market. The reset factor was constantly cited as a reason why the Subprime mortgage fiasco is still – to this day – a ticking time bomb.
If interest rates were to spike today, subprime rates would follow suit, along with delinquency and default rates soon after, as a bevy of homeowners are forced to acknowledge reality and face foreclosure. This would undoubtedly reignite the disaster still sitting idle on bank balance sheets.
But where the Fed has succeeding in stifling the subprime blowback, another equally distressing time bomb sits right next to the subprime mortgages.
Look at the chart above and you’ll notice the substantial volume of Option ARM mortgages that will soon be facing a reset. This is why the Fed needs to buy mortgages and keep interest rates at record lows: so that the ARM resets can fly through without setting off another wave of foreclosures.
It’s a bad time to run out of stimulus ammunition, and any misstep here will send the economy into a tailspin.
Andrew Packer
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