As the week got underway, up-in-coupon mortgage trades were beginning to feel the love again as investors began to discount the risks of a government-induced refinancing event.

Last week, there were numerous mortgage-backed research that came out following the publication of a report by Morgan Stanley economists called Slam Dunk Stimulus. The economists from the firm said that the U.S. economy could receive an immediate significant boost, without impacting the budget deficit, if "the government merely recognized its existing guarantee on the principal value of a large part of the mortgage market — the mortgages that are backed by Fannie, Freddie and Ginnie — and acted to streamline the refi process."

Before the report, mostly market players believed that the only way higher coupons were able to refinance was through government programs beyond the Home Affordable Modification Program (HAMP) and the Home Affordable Refinance Program.

Most MBS analysts, however, believe that the odds of such an aggressive program happening are very low given the hurdles to develop it, among other things.

The reassurance given by MBS analysts seemed to work as real and fast money investors were buying in 5.5s and 6s through Wednesday. 

However, a new round of speculation on Thursday morning caused up-in-coupon agency MBS to underperform once again, according to a Bank of America Merrill Lynch report released yesterday.

This episode of market anxiety was caused by a Reuters news article that argued that the Obama administration could have a dramatic announcement ahead of the upcoming elections to forgive principal for underwater borrowers.

As a result, the Treasury department released a press statement clarifying that the U.S. Treasury is not considering allowing Fannie Mae and Freddie Mac to forgive residential mortgage debt that goes over a property's current market value.

Considering current historically high agency MBS dollar prices, analysts said that the market's nervousness is fairly high that something dramatic could happen prior to the election season that would result in the MBS coupon stack repricing because of policy changes like these.

"We warn investors not to overreact to news articles about changes that are already planned," BofA Merill analysts said.

Nevertheless, BofA Merrill analysts believe that the housing market remains "fairly fragile." The government, they said, is probably going to enhance the existing Making Home Affordable program to improve effectiveness.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.