Hope is not a good risk management strategy.  Originating good loans is.  Credit Suisse just reported that they were “frankly shocked” at the disparity between the performance of various GNMA issuers.  A recently-seized issuer is the worst of the bunch with over 23% of its GNMA pools seriously delinquent.  Wells Fargo posts the best numbers:  less than 1% of Wells’ pools are seriously delinquent.

A year ago, an additional 0.50% of mortgage yield would have bought you a measly 1.00% price increase above par.  The Fannie Mae 4.0% MBS traded at 100; the 4.5% MBS traded at 101.  As you may recall, the mortgage investment world was gripped with fear (and hope, depending on which side you were on) that every mortgage was going to refinance in to a sub-5.0% rate.

The world is different now.  0.50% of yield will buy you a whopping 2.75% price increase, nearly triple the level of a year ago.  Why is the spread so great today?  On the one hand, the fear and hope of refinance is all but gone (we refinanced almost everyone eligible in the first half of 2009), and prepayment speeds imbedded in higher coupons are much slower than they were a year ago. On the other hand, the Fed is buying MBS across the coupon stack, including the premium coupons.  That’s just another reason to be concerned about the Fed’s exit from the market over the next few months.  Premium coupons are likely to compress when the Fed’s bid goes away.

The debate rages on:  “I’m not going to say there will be no effect on rates (when the Fed exits the market), but we do think you are seeing market signs and market signals that there should be an orderly transition,” opines Michael Barr from the Treasury Department.  In sharp contrast, mortgage and real estate players offer dire warnings of a sudden jump in rates (+1%, +2%, +3% more!).  The spread between 30-year mortgage and 5-year Treasury yields has hovered around 2.00% for a year.  It reached 3.50% at its worst in 2008; estimates range from 2.50% to 3.50% as 2010 unfolds.

Regardless, the Fed’s exit seems likely.  Rhetoric from the Treasury strongly suggests that Fed purchases will end soon.

Meanwhile, there is no lack of demand for Treasury securities (which is a good thing since the Treasury will auction a record-tying $118 billion this week).  A flight to quality is underway, owing much to President Obama’s introduction of the “Volcker Rule,” rate increases in China, a looming default in Greece, questions about Bernanke’s confirmation, and all manner of things uncertain.  Risky instruments are trading lower in exchange for the relative safety of U.S. government debt.

Doug Kass thinks that we might be surprised by… “The yield of the 10-year U.S. note drops from 4% at the end of the first quarter to under 3% by the summer and ends the year at approximately the same level (3%). Despite the current consensus that higher inflation and interest rates will weigh on the fixed-income markets, bonds surprisingly outperform stocks in 2010.”

Those are Treasury yields that Doug is thinking about, not mortgage yields.  Even if the 5-year Treasury yield drops below 2.00% (it is 2.36% now), mortgage rates to the consumer will probably remain above 5.00%.

I just want to mention that if anyone wants to pay me 45 million dollars to go home, I’ll go. – Jimmy Kimmel

Thanks for your business, and have a good week.               – Tom Millon

Market	Close	Wk Chg
30-Yr Agency Note Rate	4.99%	-0.07%
30-Yr Mortgage Yield	4.38%	0.01%
Note Rate vs. MBS Yield	0.61%	-0.08%
Mortgage-Treasury Spread	2.02%	0.06%
10-Yr Treasury	3.61%	-0.07%
2-Yr Treasury	0.79%	-0.07%
10yr- to-2yr Spread	2.82%	0.01%
Fed Funds	0.12%	0.00%
Fed (April ‘10)	0.16%	0.00%
Fed (Aug ’10)	0.28%	-0.05%
Dow Industrials	10,173	-437