After election, a big sell-off in residential MBS market

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One consequence of President Obama's reelection has been big changes at the Federal Financing Housing Agency, which oversees Fannie Mae and Freddie Mac.

The administration has let it be known that it intends to replace Edward DeMarco, who had become something of a black sheep for the administration. He ended up frustrating the administration's efforts to use the two big housing GSEs to effect more principal reductions, arguing that the while taxpayers might ultimately win in such efforts, the overall benefits of the program did not outweigh the costs and risks.

That made him something of a hero in the ABS market, in which "investors were paying up to 111 percent of face value for Fannie Mae-guaranteed MBS with a coupon of 6 per cent, in the belief that borrowers in the underlying pools of loans were largely trapped into their mortgages and unable to take advantage of rates on new loans that are at their lowest levels since the 1950s," according to the Financial Times.

"The 6 per cent coupon MBS fell from 111 the day before the election to 110.34 at the end of last week, and 5.5 per cent coupon securities fell from 109.75 to 108.81, their largest price swing this year." But now that DeMarco is out, the market has sold off in a big way, taking massive haircuts on these securities in what has been dubbed the "DeMarco trade."

The view is that whoever replaces him will work hard to effect more modifications, which are always rough on the MBS market.

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