Traders reported the most volatile trading this year in some MBS amid speculation that the Obama administration would remove at least some hurdles to refinancing for borrowers with weaker credit and whose loans are underwater. The administration has been weighing numerous options to stabilize the battered housing market--a key source of weakness in the economy.
Administration officials have been studying ways to increase the number of homeowners who can refinance, but haven't settled on a definite plan.
Just chatter about such changes is upending a profitable trade on MBS backed by loans with rates at 6% and higher. Investors, who are hurt when a loan is refinanced, had flocked to those bonds for stable refinancing levels because any borrowers that could have refinanced would have likely already done so. Investors swapped into lower rate MBS.
Analysts have been assessing numerous options that they expect are under consideration by the government. Included are possible changes to expand the Home Affordable Refinance Program--a program rolled out in 2009 designed to help borrowers refinance loans if they owe more on their mortgages than their properties are worth. It has assisted 810,084 homeowners through May, far short of initial expectations.
Other ideas include limiting lenders' exposure to defaults; expanding HARP eligibility to the newer originations; or implementing parts of a bill from Sen. Barbara Boxer (D., Calif.) that would drop fees and eliminate a restriction limiting the program to homeowners who owe more than 125% of their home's current value.
Analysts say a "nuclear option" in which a low mortgage rate would be made available to all borrowers is likely to be unrealistic. That is because it would be subject to legal challenges, and could alienate the investors that provide funding for 90% of all loans, said Ankur Mehta, head of agency MBS at Nomura Securities in New York.
Peter Swire, a former top White House housing adviser, said administration officials are well aware of such concerns from the financial market.
"The administration goal is to return private funding to the housing market, not to cut it off," he said.
Another key problem for Obama officials is that the independent regulator for mortgage giants Fannie Mae (FNMA) and Freddie Mac (FMCC) would have to approve the program. That regulator, the Federal Housing Finance Agency, has resisted Obama administration programs, arguing they would boost losses at the two government-controlled mortgage funding firms.
Administration officials sought to downplay the potential scope of any changes. But analysts believe chances for action are increasing as growth disappoints, because refinancing could save homeowners $85 billion a year.
"We continue to look for ways to ease the burden on struggling homeowners and to help stabilize the market, whether that's through assessing new proposals or older ones worth re-considering as market conditions change," the White House and Treasury Department said Thursday in a statement. "That said, we have no plans to announce any major new initiatives at this time."
Prices on Fannie Mae 6% MBS have plunged 1 13/32 to a price of 109 31/32 cents per dollar since Aug. 12, compared with a 26/32 fall for 4% MBS to 103 20/32 according to TradeWeb. High-priced MBS are most vulnerable as a refinance triggers a prepayment of principal to the investor at 100 cents on the dollar.
Investors are caught between benefits from the high carry of 6% MBS and the safety of lower coupon bonds. MBS had rallied earlier this month after the Federal Reserve pledged to keep its target interest rate near zero for at least two years, giving banks and real estate investment trusts comfort that their models of investing borrowed funds would be profitable for some time.
Their risk to MBS is greater as prices have hit record highs this month, according to Barclays Capital.
The high prices make any increase in prepayments especially painful, said Walter Schmidt, head of MBS strategy at FTN Financial in Chicago.
--Nick Timiraos of The Wall Street Journal contributed to this article.
-By Al Yoon, Dow Jones Newswires