Mish's Global Economic Trend Analysis Message Board

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Strategies & Market Trends : Mish's Global Economic Trend Analysis

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To: CalculatedRisk who wrote (559)	2/24/2004 8:46:29 PM
From: mishedlo	Read Replies (4) of 116555

Greenspan Interest rate risk associated with fixed-rate mortgages, unless supported by substantial capital, however, can be of even greater concern than the credit risk. Interest rate volatility combined with the ability of homeowners to prepay their mortgages without penalty means that the cash flows associated with the holding of mortgage debt directly or through mortgage-backed securities are highly uncertain, even if the probability of default is low. Mish comments This is the KEY sentence: Interest rate volatility combined with the ability of homeowners to prepay their mortgages without penalty means that the cash flows associated with the holding of mortgage debt directly or through mortgage-backed securities are highly uncertain, even if the probability of default is low. This is a warning about prepayment! Why would someone prepay? Because rates are headed LOWER, not higher. FNM thinks it has locked in long term returns and has hedged around that. Unfortunately someone pre-pays and that royally F's up FNM if their hedges are correct. Since FNM is one of the most leveraged players on the planet they are at great risk of prepay. In actuality, FNM is reversed hedged. FNM has bet rates go higher. They need to do this in case rates go up. If they do not then FNM would be content with what they get, except they are WRONGLY hedged AND the customer pays off the loan. oops! This scenario in fact cost FNM billions of $ thet they reported as a "one time charge" last summer. Thus FNM has these risks 1) They are hedged the wrong way 2) they are not hedged enough 3) prepayments get them even if they are hedged the right way 4) leverage 5) defaults and bankruptcies That is what Greenspan is bitching about IMO. Mish

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