Investors Rush to Scoop Up GSE Mortgage Debt

While Treasury yields plummeted on low notes sounded by investors over panicked markets, recently downgraded GSEs ""Fannie Mae"":http://www.fanniemae.com/kb/index?page=home&c=homepage and ""Freddie Mac"":http://www.freddiemac.com/ continue to see spikes in interest from investors over their mortgage-backed debt. ""_The Financial Times_"":http://www.ft.com/cms/s/0/65f20b16-c430-11e0-ad9a-00144feabdc0.html#axzz1Ul0xMBWq attributes the investor rush to the market bonanza created by the ""Federal Reserve"":http://www.federalreserve.gov/, which decided Tuesday to keep interest rates at historically low levels until 2013. Some analysts say the investor rush to agency debt could crimp financing for U.S. federal debt and potentially frustrate mortgage rates.

[IMAGE]

Investors ran to agency debt on news that yields for mortgage-backed debt jumped to a new peak in two years, attracting more to the debt sector, according to the _Times_.

The publication reported Bill O'Donnell, an ""RBC Capital Markets"":https://www.rbccm.com/ strategist, as saying that mortgage-backed securities would benefit from the market search for new yield, with a number of securities offering up yields valued at several percentage points above Treasury debt.

""There's a hundred basis points to be had,"" the _Times_ quoted O'Donnell as saying. ""Obviously you take on some pre-payment risk, but with rates low and stable, I would expect those, except for spurts like now, to stay stable.""

The publication also quoted Matt Toms, ""ING Investment Management's"":http://www.inginvestment.com/US/Home/index.htm head of U.S. public fixed income, as describing the mortgage market as one that slacked off in the aftermath of ""Standard & Poor's"":http://www.standardandpoors.com/SPComIPResolver downgrade of U.S. debt and Fannie and Freddie.

[COLUMN_BREAK]

""The mortgage market has moved beyond fear of what the downgrade meant to a Fed that will keep rates low for a long time,"" Toms said, according to the publication.

Speaking to _MReport_, Edward Pinto, a resident fellow at the ""American Enterprise Institute"":http://www.aei.org/ (AEI), casts the competition between U.S. Treasury and GSE debt as one that crimps the ability of the federal government to finance its multi-trillion-dollar debt.

""The agency debt held by Fannie and Freddie is competing with Treasury debt and driving the costs of interest rates and prices down,"" he adds. Commenting on the rise on mortgage rates this week, he ties the agency debt buy-up by investors to the potential for declines in ""underlying rates, because mortgage rates are tied to 7- and 10-year Treasuries.""

Writing for AEI's ""_The American_"":http://www.american.com/archive/2011/july/the-government2019s-four-decade-financial-experiment, Pinto's colleague, Alex Pollock, outlines the consequences of the competition between public and agency debt since 1970. According to Pollock, the Treasury debt, amounting to $290 billion in 1970, easily trounced $44 billion in existing agency debt. The housing bubble burst in 2006 raised Treasury debt to $4.9, alongside GSE debt, which skyrocketed to $6.5 trillion.

With investors scooping up trillions in GSE debt, Pinto and Pollock argue that the federal government exposes taxpayers to the risk of failure and collapse.

It is unclear how the investor stampede to U.S. and GSE debt, as reported by the _Times_, will impact the deficit and mortgage markets.

""Can we really afford, as a country, to use our national debt card to take on all these exposures?"" Pinto postulates. While good for investors, these implicit and explicit government guarantees impact ""our ability to finance our own national debt, and the more government-guaranteed debt, the bigger the supply, and the bigger impact it will have on interest rates, particularly those controlled by the Federal Reserve.

""I think we need to start weaning ourselves off of these federal government guarantees,"" he says.