Two pieces of news caught the attention of The Bear this morning. First, there is this story that the Federal Reserve is having all sorts of trouble selling the assets it took from AIG as collateral when the insurance company was circling the drain. Judging from today’s report, it seems that this one seller is simply overwhelming current demand for these mortgage-backed securities.
The second piece of news comes courtesy of Clusterstock which points out that prices on both residential and commercial mortgage backed securities have been plummeting over the past month. AAA-rated subprime residential paper has moved from the low 40s to the mid-30s while some AA-rated commercial junk has dropped from the low-70s into the high-50s. That folks, is a rout.
Obviously, these two news items are related as selling pressure from the Fed is at least partly responsible for falling MBS prices. In fact, these stories probably belong under the same headline. Something like …. “Shadow Banking System is Still Busted.”
I say that because taken together, this news suggests that private investors – hedge funds, investment banks, insurers and pensions – are hardly itching to buy mortgage-backed securities and certainly not at the prices that the Fed has been buying them for two years. And now that the Fed is long a ton of this stuff and wants to unwind hundreds of billions worth of securities, nobody is willing to stick their toe in the water, let alone step up with big bets.
The consequences of this buy-sell imbalance is profound because it means the only thing standing in the way of much tighter credit is the Fed’s balance sheet. And if the Fed isn’t willing to support these issues with added purchases (QEIII and IV and V ….), prices will fall, financial institutions will have to mark down their trading books, and credit figures to get much more expensive, if obtainable at all. This is not a recipe for growing the economy. In fact, it is a rather foul concoction that may go a long way toward contracting the economy in the not so distant future.
