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July 02, 2009
The Future of Mortgage-Backed Securities
Once the housing market is back on its feet, will any traders still deal in mortgage-backed securities? This is anyone's guess. But the financial crisis exposed one crucial reality - homeowners will default on mortgages. Essentially, this means that the default risk on mortgages will predict the future of the mortgage-backed security market.
While default rates are still high (blame unemployment and a lack of financial security), house prices are still low. This sounds like a bad mix - why would anyone invest in an asset with low return and high risk? But all hope is not lost.
Lower prices mean that homes are more affordable. And as the recession enters its last stages, unemployment will begin falling, albeit at a very slow rate. As unemployment falls, consumer confidence and spending will slowly increase again. This means they will be more willing to invest in assets, namely houses. And as anyone familiar with the supply-and-demand framework will tell you, a spike in mortgage demand will cause house prices and interest rates to rise again. In a perfect world, investors would start trading mortgage-backed securities again.
Granted, this cycle would take another five or so years so don't hold your breath waiting for the mortgage-backed market to reemerge. Also, investors would still be wary of buying on the secondary (investor-to-investor) markets, where most of the bad loans are.
The point is simple. Even if the housing market returns to its pre-crisis state, it will not be easy to regain investor confidence. The mortgage-backed security market might become popular again. But it will never be close to what it once was.
Posted by iaijazud at July 2, 2009 08:06 PM