Mortgage Backed Securities: Its a trap!

More on interest rates, from Accrued Interest:

The agency-backed mortgage sure is tempting. Fannie Mae 30-year 6% mortgage-backed securities are currently yielding in the 4.40% area with just a 2-year average life, based on Bloomberg figures. That looks pretty good compared with 2-year Treasuries at around 0.66% and 2-year Fannie Mae bullet debt at around 1.50%. Now that Fannie Mae and Freddie Mac are owned by the government, one should view these credits as all the same. Why not take that extra yield?


But beware, there is likely to be a massive difference in MBS performance over the next year, as the government works hard to push mortgage borrowing rates lower. When a borrower repays his/her mortgage in part or in full, that repayment is passed through to the investor at $100. With almost all agency-backed MBS priced at $102 or above, investors will be taking a loss on every loan refinanced. Thus gauging the potential refinancibility of your mortgage-backed security as well as predicting the direction of government policy will be the key. This is especially true of those holding agency CMOs, which remains a popular product among individual and bank investors....MORE