Banks get housed
The big buys banks made in mortgages are coming back
to haunt them.
July 29, 2003: 2:25 PM EDT
By Justin Lahart, CNN/Money Senior Writer
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.
money.cnn.com |
