A Commercial Mortgage-Backed Security, also known as an MBS, is a type of asset-backed security. Less the additional rules and regulations surrounding asset-based securities created after 2008, the guiding principles of an MBS have remained relatively the same. The investment is a bundle of home loans bought from the banks that issued them. Once you take on a home loan subsequently become responsible for paying that loan’s mortgage. It just so happens, that it’s a bundle of those 1000’s of mortgages that finance the “periodic payments” of the MBS. To put it simply, an MBS functions like a bond that is backed not by the government or a company, but by the expectation that people will pay their mortgages. That’s why investors are more than happy to take on the risk of an MBS during a booming economy because default rates drop like a stone. On the flip side, during turbulent markets, an MBS becomes a far less attractive investment because actors like fortune 500 companies or the federal government who also happen to issue their own securities become far more reliable than the American homeowner.
Considering this logical trend, it came as a shock to many investors that demand for an MBS has remained relatively stable. The demand for an MBS is measured by the basis point spread, which is the difference between the yields of the MBS and a government bond. So, if an MBS is trading at a lower basis point spread (bps) that means that investors are confident enough in the mortgages that back the security that they are willing to receive a lower yield on their MBS. During the years leading up to the 2008 crisis, an AAA-rated MPS was trading at approximately 25 bps. Since the crisis, the average MBS has traded at 80-100 bps. As of August 22, 2020, an AAA-rated MBS is trading at only 105 bps. For context, in 2008, once the crisis began, there was an understandable and severe loss of trust in financial institutions that created securities resulting in an AAA-rated MPS trading at a whopping 750 basis points. Considering previous reactions to recessions in the MBS market, an AAA-rated MBS trading at 105 bps in today’s economic climate is surprisingly stable and unproblematic.
Why exactly have MBS rates stayed consistent throughout what has been the most turbulent year of the last century? The Fed, with their already massive 2020 balance sheet of 7.1 trillion dollars, has been buying mortgage-backed securities to the tune of 120 billion dollars a month. The efforts are a part of the Fed’s effort to keep credit flowing and put downward pressure on mortgage-backed securities. At the moment, we are watching Wall Street and Main Street play a trillion-dollar game of tug of rope. Investors want higher yields on their mortgage-backed securities from MBS sellers to compensate for the risk associated with the turbulent market, while the government is keeping yields and mortgage rates low by buying billions in securities at their current rate. If the investors win then banks will bump up rates on their adjustable mortgages to offer investors more attractive yields on the securities, and the Fed justifiably believes that would only worsen the crisis. Any game of tug of war has a winner, so all we can do now, is hold are breath and wait until a side keels over and surrenders to the will of the other.
Downey, Lucas. “Swap Spread Definition.” Investopedia, Investopedia, 20 May 2020, www.investopedia.com/terms/s/swapspread.asp#:~:text=A%20swap%20spread%20is%20the%20difference%20between%20the,indicative%20of%20greater%20risk%20aversion%20in%20the%20marketplace.
Howley , Kathleen. “Fed Pledges to Maintain Current Pace of MBS Purchases.” HousingWire, 11 June 2020, www.housingwire.com/articles/fed-pledges-to-maintain-current-pace-of-mbs-purchases/.
MBS Dashboard – MBS Prices, Treasuries and Analysis, 22 Aug. 2020, www.mortgagenewsdaily.com/mbs/.
Woodwell, Jamie, and Reggie Booker. “CMBS Spreads & Issuance: Mortgage Bankers Association.” MBA, 24 Jan. 2020, www.mba.org/news-research-and-resources/research-and-economics/commercial/-multifamily-research/blog/blog-posts/current-blog-posts/cmbs-spreads-and-issuance.