THE MORTGAGE MARKET

GUARDIAN CAPITAL

THE MORTGAGE MARKET: NEW POLICY
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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 GUARDIAN CAPITAL

THE MORTGAGE MARKET: PAST WEEK
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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
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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 market²where investors exchange fixed for floating-rate interest payments²turned negative this week This forced selling ofTreasuries, adding to the push higher in yields

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THE MORTGAGE MARKET: QUANTITATIVE EASING ENDS
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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 nonproducing 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
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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 mortgagebacked over the next couple of quarters
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THE MORTGAGE MARKET: QUANTITATIVE EASING ENDS
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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
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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
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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 GUARDIAN CAPITAL

THE MORTGAGE MARKET: NEGATIVES
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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, 10year 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
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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 riskadverse 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 GUARDIAN CAPITAL that in an election year

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
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Government is delaying the inevitable: individuals cannot afford their homes and more write downs are due Mortgages are overvalued across the board Now thelargest 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
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http://www.marketwatch.com/story/another-doomedplan-to-prevent-foreclosures-2010-03-26 http://www.zerohedge.com/article/january-fanniemae-delinquency-rate-climbs-new-record-552-14bps-higher-january-double-yearhttp://www.zerohedge.com/article/24-hours-until-endmbs-purchases-fed-then-what

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