Currently, U.S. mortgage debt outstanding is $10.5 trillion, with $500 billion of equity support, or a leverage ratio of 20 to one, but Mr. Miller wrote that ratio would have to be cut to about 14 to one to stabilize. That would require about $150 billion to $250 billion of new permanent investment capital.
At present, however, “this imbalance between equity and total mortgage debt outstanding is resulting in abnormally low bids for mortgage assets, especially in the non-agency market,” Mr. Miller wrote.
Making it tougher for investors is that “prices need to adjust on all mortgage products in order for new capital to achieve attractive returns. This will be painful, but it must be allowed to play out in an orderly fashion in order for the mortgage market to achieve normalized returns,” according to Mr. Miller’s report, entitled “De-Leveraging Destroying Value—New Capital Needed.”
Unfortunately, “there is no quick fix here,” he wrote, estimating that it will take six to 12 months for the prices of mortgage assets to adjust and for capital to flow back into the space.
So until then, those holding MBS paper are going to continue to suffer financially.
He said the root cause of the deleveraging “is that investors believe the collateral has been impaired, since they expect home prices to decline materially over the next year.”
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