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Obama's "Mickey Mouse" Plan to Save The Nations Housing Market

Now do a flow of funds for this mega transaction. I) Homeowners get a new loan at 4% and payoff 100% of the old mortgage. II) The servicing banks get the proceeds and pay off the old loan. III) The money is paid to F/F. This money is used to redeem existing mortgage pools of Agency MBS. IV) Fannie/Freddie have the same asset mix at the end of the day. They still need to finance the new 4% mortgages they are writing. V) Fannie and Freddie are taking on substantial new risk as they now have a book of 4% mortgages and are much more at risk to rising interest rates. VI) It takes 90 days for a new mortgage to become a new Agency MBS. During this period F/F warehouse these loans. They finance the warehouse with short-term debt. They take action to reduce their risk by entering into new swap transactions or by buying derivatives to neutralize the market risk. VII) As the process goes on huge chunks of EXISTING higher coupon MBS are prepaid. Investors in those MBS securities will be forced to re-invest the proceeds. So who is going to be the biggest recipient of the cash pre-pays? That’s easy to answer. It’s the Federal Reserve. They currently own 1.0 Trillion of Agency MBS. A very substantial portion of the total prepayments of F/F MBS will be paid to the Fed. The Fed’s balance sheet will shrink very rapidly as a result. The Fed has already established what will happen when principal is prepaid on their holdings of MBS. The have said they will reinvest any proceeds back into new purchases of US Treasury securities. As this chart of the Fed’s holdings show, this has already happened to the tune of $250 billion. The new proposal for the mega ReFi will dramatically reduce the MBS holdings. It will force the Fed back into the market to purchase big amounts of Treasury bonds. This process will take at least a year. But the total amounts could easily exceed $600 billion (QE2 size).

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