A Few Examples of the Not-So-Free-Market


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The picture above is of 30-year Fannie Mae (FNM) 4.5% mortgage pools. Note the recent 13% spike, as the Fed announced that it would be buying MBS in order to stabilize the mortgage market. In a free market, these securities would be many points lower; however, because there is an artificial bid (yep, with our money), investors are forced to look elsewhere, toward risky assets.



The chart above may be confusing, but it's actually rather simple: It's the screen our Head Trader and I look at all day in the land of mortgage-backed securities.

If you focus on the middle section, you'll note that 7% Freddie Mac (FRE) (FGLMC) pools trade at the same price as Freddie Mac 6% pools and lower in price than 6.5% pools. This is yet another example of how the markets have become so disorderly and difficult to trade.

For the icing on the cake, feast your eyes on what the Prudent Man would invest in during times of rebuilding one’s balance sheets: Treasury bills.

Yes - cash is now officially trash. If you buy 1-month Treasury bills, you're rewarded with a yield of a gigantic 0.02% per year. That’s right - 2 basis points per year. I suppose people with more than enough money can keep it invested for an entire year and make nothing - or they can succumb to the pressure of “I can’t make zero forever if I hope to retire.”

Now, imagine that you're a professional money manager who's paid 1% annually to invest other people’s money. If you feel that being prudent is to sit on cash and attempt to charge a fee, the math is simple: 0.02% per year minus any reasonable fee is a negative return. This is forcing many people out onto the risk spectrum at precisely the wrong moment - when risks are at their highest ever.

While I have taken some profits, as I mentioned earlier, I remain rather fully invested in higher-coupon mortgage-backed securities, which I feel have a low chance of being refinanced and will provide an adequate (4-6%) return while we wait for the dust to clear.