Sunday, April 21, 2013

A Banker on the Fears of the Fed

The Federal Reserve is doing aggressive buying of mortgage backed securities, which is what is likely behind the fact that banks are slowing down the number of mortgages they are originating. They know that once the Fed stops buying MBS paper rates will shoot up. A banker friend emails:

 A bank wouldn’t want to get caught holding MBS paper that will evaporate in value if rates spiked. I could be wrong, but something is not right here and I think it smells more of Fed fear of the obvious: the economy now is totally dependent on them keeping rates down.  If rates were to go suddenly up, say 75 – 125 bps at minimum, all hell would break loose.

Incidentally, the regulators for the last several years have been religiously insisting banks do stress tests, or what we call interest rate risk scenarios, where we examine the effect on income and capital if rates were to suddenly shock up 100 to 400 bps.  No historical context for rates going up that rapidly, mind you, but they demand we do these scenarios anyway.  Wanna know what happens to bond portfolios if rates shock up like that?  They get murdered.

 A vicious cycle seems to be at our doorstep here.  It’s more scheme than sound economics.

Strange behavior for a country supposedly in recovery, don’t you think?

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