Last week, the New York Federal Reserve announced that it will accept Ginnie Mae, Fannie Mae and Freddie Mac mortgage-backed securities as collateral in repurchase transactions, making dealers more willing to hold mortgage inventories over year-end.
The news engendered a positive reaction on Wall Street, since dealers no longer have to worry about how they are going to fund pass-throughs over year-end, especially with Y2K pressures hovering over them.
"I think this is very, very positive for our market," said Laurie Goodman, head of mortgage research at PaineWebber Inc. "It makes dealers more willing to position mortgages. Additionally, commercial banks will dump a lot of cash. The fact is that the Fed has a liquidity facility available now that alleviates the need to make [banks] obsessed with holding cash. It will cause a big source of demand for the market."
According to Goodman, banks' holdings of MBS have plummeted from $266 billion in late 1998 to $234.6 billion in August, reflecting banks building up cash in anticipation of Y2K.
"Mortgage securities were one of the easiest assets to reduce exposure in - you didn't need to sell, if you let your assets prepay without replacing them, holdings decline," wrote Goodman in a PaineWebber report.
In addition to the expansion of collateral, which will begin in early October, the Fed also designed two other measures in its quest to increase liquidity: the maximum term of the New York Fed's repo facility will be expanded, and the introduction of a standby financing facility.
The expansion of collateral was approved through April 2000, and the Federal Open Market Committee intends to review its experience prior to this date.
"The entire mood of the mortgage market has improved, and I think it is a good thing," added Art Frank, head of mortgage research at Nomura Securities.
"The Fed is trying to mitigate the need for a spike-up in short-term rates," explained a trader. "This will alleviate pressure on Treasury issues in the repo market. Now, dealers know they can finance mortgages if the roll market happens to get very expensive, and they are more comfortable holding mortgages at the margin, versus either cash or Treasurys."
In response to the New York Fed's actions, Goodman would urge investors not to sell yet, since the announcement will alleviate fears that have cropped up in the market recently caused by liquidity concerns.
"Actually, we would consider adding to mortgage exposure," she said.