Gretchen Morgenson of the New York Times reports that Mortgage Markets are Out of Control. The mortgage-backed securities market is the place where bundles of home mortgages packaged into debt securities are traded. The MBS market is now the largest debt market in the world, having eclipsed the US Treasury market. The two Government Sponsored Enterprises (GSEs) — Fannie Mae and Freddie Mac — the largest issuers of MBS, are roiling the US Treasury market as they buy and sell enormous quantities of treasuries in their attempts to hedge interest rate risks on their own portfolios. Hedging is an attempt to insure themselves against interest rate movements. The problem here is that at this point the GSEs are so large that they are the market. Insurance is based on the pooling of a large number of independent risks. As we are seeing here, the entire system cannot insure itself against the failure of the entire system.
James A. Bianco of Bianco Research in Chicago pointed out that the last time interest rates moved up — in the mid-1990’s — the mortgage-backed securities market was much smaller and more manageable. “Back in 1996, the mortgage market was roughly half the size of the Treasury market,” he said. “Now it is 125 percent of the Treasury market.”
Mr. Bianco fears that the size of the market and the fact that so many players are heavily leveraged make a disaster almost inevitable. “If you look at the last 15 years of bond market derivative debacles, a lot of them involved mortgages,” he said. “These things have killed more people than any other trade.”
