A controversial Federal Reserve Board-sponsored study which concluded that GSE securitization activities may not actually lower mortgage rates for borrowers was almost unanimously shrugged off by the mortgage-backed securities market last week.

Several market participants which were contacted used words such as "ridiculous," "weird" and "surreal" to describe the study.

The 39-page report, entitled "Credit Scoring and Mortgage Securitization: Implications for Mortgage Rates and Credit Availability," essentially finds that mortgage rates are determined more by a lender's cost of holding a mortgage than by the liquidity benefit offered by securitization.

"I think this makes no sense at all," said one MBS veteran. "They're trying to say there is no link between lending rates and MBS secondary-market rates, but that's not the case. [Lending] rates are generated from both prices in the MBS market and from interest-only (IO) prices."

"I think the big question is, do the authors of this study own or rent?" quipped Steve Point, an MBS investor at The Glenmede Trust Company. "The standardization that the agencies bring to bear with regard to underwriting standards and uniformity in loan packaging, as well as dissemination of information and increased efficiency, is definitely a meaningful amount."

One of the key questions asked by the three authors - two of whom are academics and the third, Wayne Passmore, an assistant director at the Federal Reserve Board - is whether the benefits achieved by a securitization get passed on to borrowers. According to the study, the liquidity benefit of securitization does not truly translate into lower mortgage rates and/or greater access to credit.

A highly mathematical, calculus-laden theoretical model devised by the authors is used to prove that a decline in mortgage rates causes the volume of securitization to rise, "a reversal of causation from previous interpretations," the report states.

"The liquidity premium' from securitization acts as a subsidy to originators on their infra-marginal mortgage borrowers, but it does not necessarily alter the opportunity cost of serving the marginal borrower," the study asserts. "Yet, this marginal cost determines the equilibrium mortgage rate at the point of intersection with the borrowers' marginal benefit function. This theoretical result suggests that the liquidity premium from securitizing mortgages may have little or no effect on mortgage rates."

But according to David Jeffers, spokesman for Fannie Mae, the best way to study what effect the GSEs have on mortgage costs is to open any local newspaper's real estate section and look at the mortgage charts.

"Week in, week out, there is a 25 to 40 basis point differential observable between conforming and jumbo mortgage rates," Jeffers said. "Despite all of his concerns regarding our oversight and other legitimate policy concerns, Rep. Baker never questioned whether we lower consumer cost or provide an important service to the country. Our role in aiding homeownership was never questioned until now."

Of course, some of the differential between the two types of loans is attributable to size differences in jumbo loans, and less homogeneity within that sector. But overall, Jeffers' point was well taken by MBS experts.

"[The authors] have a theoretical model, but in practice it is very hard to believe that Fannie and Freddie Mac don't lower mortgage rates," added Art Frank, head MBS researcher at Nomura Securities.

Try Comparing it to Corporates!

In opposition to the study, most market players strongly believe that the MBS market and primary lending are inextricably linked at this point.

For instance, whole-loan passthroughs are generally quoted as a spread behind Fannie bonds, and mortgages would be trading much lower if Fannie and Freddie were not in the market.

"The GSEs are the biggest buyers in the market," said the MBS veteran. "They were in the market in the fall of 1998 for awhile. It was not that they were being altruistic, it is just their economic function."

Michael Hoeh, MBS money manager at Dreyfus Corp., added, "It is kind of insane to suggest all of this about two entities that have been wrapping more than 80% of mortgage loans. In fact, many think that the GSEs have made it too easy to get home loans. Perhaps they have not been as successful in the last two years at tightening mortgage spreads, but in the absence of Fannie and Freddie it would be much worse."

Not only would yield levels on mortgages be substantially higher if the GSEs did not do what they were supposed to, but the agencies have also created standards in the mortgage market that have narrowed the spreads between agency paper and jumbos. In other words, jumbo providers use the agency models to benchmark pricing.

Moreover, the mortgage market is comparatively liquid when compared to the corporate market, which has been in an extremely weak state recently.

"What if the liquidity in the mortgage market during the month of October deteriorated to what it was for corporates?" said Glenmede Trust's Point. "The bid-offer spread was so wide. But because of the GSE standard issuance, you have a much more efficient market. In fact, there is more standardization in Fannie and Freddies than in Ginnie Mae bonds."

GSE Bashing?

Although the Federal Reserve Board's research team is a highly regarded think tank whose job it is to make sure the GSEs honor their charter, some sources did bring up the spectre of political motivation.

"The Federal Reserve must have an axe to grind," noted one Street source.

"Why don't they write reports about the changes in day issuance? - the fact that agencies moved towards benchmark debt, which is non-callable, and away from callable debt structures," Point said. "I don't see the Fed writing about significant issues such as this."

The fact that agencies moved towards non-callable benchmark debt has led to these bonds being placed by some of the more unsophisticated buysiders, Point said. "The Fed never said, Maybe this callable debt is too rich,'" he added.

This current study may also be used down the line as a tool by FM Watch or even Representative Baker, even though Baker never implied that the GSEs did not add liquidity to the mortgage market.

The Federal Reserve Board did not return calls regarding this topic.

"I wouldn't read any political significance into [the study]," Nomura's Frank said. "Universities and academics tend to publish a lot of fairly theoretical research."

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