Friday, 8 November 2013

Could Volde-mortgages spook US recovery?

I've a simple rule of thumb regarding housing markets, the US in particular: if a person of moderate intelligence (a category I think I just about scrape into) struggles to understand the mortgage-based products associated with that market it's probably bad news.

A few months before the US market hit its last heady peak I read on Reuters a list of almost a dozen exotic and almost incomprehensible mortgages that looked straight out of Harry Potter's Guide to Derivatives. And felt very worried. These magical products allowed people that clearly did not possess two brass knuts to rub together buy hugely inflated homes. Unbeknown to most observers, however, legions of Voldemorts within investment banks were busy slicing and dicing these into respectable looking mortgage backed securities that were soon to unleash their dark powers across the world's financial systems.

In recent days, the FT has been reporting on "novel" mortgage securities: "Reo-to-rental" (securities backed by rentals from foreclosed homes), which have, in their first manifestation, been granted "Triple-A" endorsement by ratings agencies; "M-Reits" (mortgage real estate investment trusts that invest in packages of mortgage-backed bonds), which have attracted the scrutiny of the IMF, on the basis that even a modest increase in rates could spark fire sales of the bonds, which would, in turn, raise mortgage rates sharply for consumers; and, overlaying both, the return of "slicing and dicing".

"Barring another recession, we find it hard to imagine how a relative flood of deals won't happen in the next year or two," said analysts at Deutsche (which helped structure the first Reo-to-rental deal). Funny, but wasn't it similarly innovative products that helped cause the last recession?

On fundamentals, the US housing market looks more robust than our own, based on demographics and the fact that prices were allowed to reach a natural level (their politicians do not share the obsession of ours with artificially supporting or stoking prices). But dark, external forces could make the whole recovery go up in a puff of smoke.


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