The big buys banks made in mortgages are coming back to haunt them.
money.cnn.com
NEW YORK (CNN/Money) - The nation's banks are bailing in a hurry.
According to the Federal Reserve's most recent report on bank assets and liabilities, large U.S.-based banks holdings in the tradable baskets of mortgages known as mortgage-backed securities fell by $42.6 billion to $360 billion in the week ended July 16. That 11.6 percent drop was the biggest one-week decline on record.
It was also a far cry from what was happening just a month earlier, when the banks were loading up on the mortgage-backeds at an unprecedented pace. The reason? With the Fed's promise to keep short-term rates low for as far as the eye can see, and chatter abounding that it would keep long-term rates low by any means necessary, buying mortgage-backed securities seemed like a great idea.
The securities, which trade like bonds, are considered a safe investment, but they carry higher rates than comparable Treasurys. Banks were playing the carry trade, borrowing money at the Fed funds rate and buying up mortgage-backeds. The difference between their borrowing cost and mortgage-backed yields they got to keep.
It was a sweet trade until rates started heading appreciably higher. Mortgage rates and Treasury prices are closely aligned, so when the yield on the 10-year Treasury hit bottom on June 11, so did yields on mortgage-backeds. But even after yields turned higher, banks held on to their positions. Perhaps it was because they thought the market would reverse itself, or they felt the trade still made sense until rates really backed up. Perhaps it was because they were wrapping up the second quarter, and didn't want to muck around with their books and risk taking charges against earnings.
When they did begin to sell, however, that sent not just mortgage-backed yields but Treasury yields higher, too, because of the way the two markets are interconnected.
"They got out long after the carry trade stopped working, and that added fuel to the selloff," said Kirlin Securities chief strategist Brian Reynolds.
Given the way bonds have kept on selling off, it seems likely that the big drop we saw in bank's mortgage-backed positions mid-month was just the beginning. And given past experience of what happens when the mortgage market reverses sharply, there's a good chance at least some of the nation's banks will take heavy hits. |
