1. Fed, MBS and You “When the facts change, I change my mind” – John Maynard Keynes

2. Objectives  1. An update on the fundamentals of the U.S. housing market  2. Analyze the effect of the end of the MBS purchases on credit markets and long term rates  3. A look at the current MBS holdings of the Fed and a viable exit strategy to these positions.

3. New Home Sales  Up 26.9% in March, 411,000 annualized units

4. Home Sales Jump in the South

5. Tax Credit

6. Existing Home Sales

7. Housing Prices Stable

8. “Glut of Trouble” – WSJ  "How much of the strength in the housing market is just the perception of government support?" he said. "I do have concern about a double dip.“ – Robert Shiller (Yale)  At the current rate of sales, it would take almost nine years to work through both the real and "shadow" inventory.  “Supply >> Demand” – Goldman Sachs

9. What is a Mortgage Backed Security (MBS)  RMBS – Residential Mortgage Backed Securities  CMBS – Commercial Mortgage Backed Securities  CDO – Collateralized Debt Obligation

10. Main Credit Indices  ABX.PRIME.AGG  What have treasurys done?  What have 30 yr rates done

11. 30 yr Fixed - National Average

12. 30 to Treasury Spreads

13. Long term real rates

14. CMBS Delinquency (CRE Market)  RealPoint: March delinquencies hit an all time high up 6%  TREPP: This number is even worse, at nearly 8%, after the single biggest monthly spike in 30 day + delinquencies.

15. Prime RMBS Delinquency  U.S. Prime RMBS delinquency now over 10%  Increased for 34 th consecutive month  Jumbo RMBS delinquincy 10.1% in Mar (up from 4.8% yoy)  Subprime RMBS delinquency rate actually fell in Mar  46.3 from 46.9 in Feb, but still well over 39.8 yoy  First decline in 4 years! (Could be seasonal anomaly

16. Spreads

17. Fed MBS Purchase Program  GSE Agency Guarantees - Fannie, Freddie, Ginnie Mae explicitly guaranteed by the govt.  What is the purpose of these guarantees, when/why did they start  Goal to help lower borrowing costs  $15-25 B a week!  Purchases as a share of gross issuance have ranged around 60 percent

18. Fed Holdings of MBS  At $1.1 trillion in holdings of mortgage debt guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae, the Fed owns roughly a fifth of all these outstanding instruments.

19. Current Balance Sheet

20. Video

21. What can you do with 1.1 T MBS?  Reverse Repo - Temporarily drains funds from system  Dealers offer interest rates at which they would lend money to the Fed versus the Fed’s Treasury general collateral (MBS)  Hold to Maturity  Sell on Market

22. Hold to Maturity  Fed has indicated these purchases were a temporary measure to stabilize the housing market and will be off- loaded to public hands as soon as possible.  Positions were bought on the cheap and have been profitable.  As rates rise, positions will fall in value

23. Fed’s Interest Rate Exposure  Fed’s DV01 is $1-1.5 Billion (Gain/loss per BP) – Alan Boyce, former Fed member  ≈75 Billion loss for first 50 bps,  What is the cost of hedging?  Interest rate swaptions, 3yr into 7yr  142 Billion – according to professional MBS trader  Fed doesn’t mark to market, but on a cash basis they go negative carry in 2015 (3 mo financing rates go above 5%)

24. Sell Sell Sell  81.5% of their portfolio is 30yr 4.0 coupons,4.5 coupons, and 5.0 coupons.  If the Fed decided to sell they would drastically erode the value of their own holdings. Overwhelm market

25. Takeaways From Ben’s Testimony  When Fed begins to sell assets, must do it in a gradual, predictable way (communication and transparency)  Fed not adding any credit risk by holding GSE MBS (because underwriting standards much tighter in 2009 and 2010)  Fed would like to get back to all-treasury portfolio in reasonable period.  Fed will be returning “Unusually Large" amount of money to Treasury in near term due to mortgage investments.

26. Questions?