Please translate this financial article into layman's terms. Also, if
possible, explain background behind Fannie May and Freddie Max -- what
they do, how they do it, etc. Thanks.....
Reuters
US SWAPS-Big spread blow-out on mortgage hedging havoc
Thursday July 31, 5:57 pm ET
By Eric Burroughs
(Updates with comment, detail)
NEW YORK, July 31 (Reuters) - U.S. swap spreads blew
sharply wider on Thursday, suffering one of their worst weeks
since the 1998 LTCM crisis as the big rise in benchmark yields
had mortgage investors hammering the market with heavy
hedging.
Five- and 10-year spreads widened dramatically, by more
than 8 basis points, in what traders described as a market in
which it was increasingly difficult to get trades done and
where dealers are struggling with the overwhelming needs of the
mortgage universe.
"This can't go on for much longer because the market can't
take this. Someone's going to get into trouble," said one head
trader at a U.S. bank.
Upbeat data showing unexpectedly strong second-quarter
economic growth, better factory output in the Chicago area and
still-declining jobless claims drove up 10-year Treasury yields
and swap rates by as much as 30 basis points during the day,
unleashing the latest round of mortgage activity.
Swap spreads came under repeated fire from mortgage
accounts grappling with major extension of the duration in
their portfolios that forces them to adjust quickly, either by
selling Treasuries or doing the equivalent in swaps, paying
fixed rates.
The duration dilemma has been compounded because mortgage
security coupons shrank as yields hit 45-year lows, making them
even more sensitive to the nearly 1.5 percentage point jump in
yields in the past six weeks. The selling drives yields still
higher and causes yet more big hedging from the $4.9 trillion
mortgage universe.
Everyone from Fannie Mae (NYSE:FNM - News) and Freddie Mac
(NYSE:FRE - News) to major banks holding mortgage-backed securities is
forced to cut
down the rapidly expanding duration, traders said.
"Any mortgage holder is getting demolished here," one
trader said.
Ten-year spreads shot up an unprecedented 8-1/2 basis
points to 58-1/2 basis points over Treasury yields and are now
nearly 17 basis points higher for the week. Five-year spreads
skyrocketed 58 basis points from 49-3/4 on Wednesday and 40-1/2
last Friday.
"The violence of the move has been astonishing," said Eric
Hiller, head of interest rate research at Banc of America
Securities (News - Websites). "Ninety-nine percent of it is mortgage
related."
Two-year spreads have also been crushed as the stock
market's ongoing gains and optimism on the economy have erased
all remaining hopes for another Federal Reserve rate cut. Some
investors are even thinking about rate hikes. The two-year
spread is out to 28 basis points from 20 late last week.
Hiller said the move was not related to credit worries in
the banking system, as sometimes can be the case in the swaps
market. Last year swap spreads popped wider when unfounded
rumors swirled about credit problems at J.P. Morgan Chase.
The selling pressure has been relentless this week and has
resulted in spreads suffering their worst widening since the
bond market's last mortgage-related plunge in late-2001 and
even the crisis days of 1998, when the giant hedge fund
Long-Term Capital Management nearly collapsed.
Making matters worse for swaps is the hefty widening of
agency spreads on reports the European Central Bank was
trimming its holdings of Fannie Mae and Freddie Mac debt. Both
agency and swap spreads tend to influence and sometimes
reinforce each other. |
Clarification of Question by
hofferino-ga
on
03 Aug 2003 22:46 PDT
Andrewxmp-ga,
I appreciate your guidance as per the recommended amounts. I was aware
that helping me to understand this article would probably require more
than $2.00's worth of work, but that's all I could afford.
I hoped someone familiar with the topic would come to my aid, and
perhaps not so much for the money, but for a laobour of love, try to
help me understand it.
As I understand it, they are GUIDELINES, but not absolute rules that
must be adhered to. I'm sorry if I've offended you.
Hofferino-ga.
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