Dennis' Mortgage Blog

Mortgages are essentially bonds, and your mortgage is bundled with others to make bond offerings.  Known as Mortgage Backed Securities (MBS), the interest you and others in your MBS offering goes to investors who purchase the bonds as a long term investment.  Mortgage Backed Securities are issued by Fannie Mae and Freddie Mac for conventional loans and by Ginnie Mae for government mortgages.

Competing with MBS for similar investment income are U.S. Treasury debt offerings (bonds and Treasury bills), corporations, and municipalities.  When there is trouble in the economy investors undergo what is known as a "flight to quality" wherein they leave the risk of stocks and invest in long term bonds--a safe haven for their investments.

As bonds become more favorable in a market cycle their prices go up, therefore their yields (interest rates) go down.  Such has been the case recently with U.S. Treasury debt that is auctioned off to sustain our $3.5 trillion budget, give or take several billion.  Part of the favorable reaction is in response to the Federal Reserve's government debt purchasing campaign, but much of the response is still coming from private, and foreign investors.

Shrugging off Standard & Poor's rating warning earlier this week, Treasury auctions this week have gone well.  Today the Treasury sold 5-Year bonds known as "TIPS" or Treasury Inflation Protected Securities.  The auction sold very well and 39% of the buyers were "indirect" buyers, or foreign banks.  This is up from prior sales meaning that foreign banks are looking for a flight to the quality of U.S. Treasuries.

What made this auction interesting however, beyond the higher prices and therefore lower interests that resulted, was that the actual yield of the TIPS was negative.  Yes, technically by purchasing the security you pay the U.S. Treasury for the opportunity to keep your money for five years as the yield was -0.18%.  For every $100,000 in bonds bought the investor owes the Treasury $180, or at the end of five years the payoff on the bond would be $99,100.  This seems like a great deal for U.S. taxpayers who need to payoff an enormous federal debt.

But not really given the structure of the TIPS bonds.  Inflation protected means that investors in the securities are betting that inflation over the next five years will be greater than the 2.11% currently offered on 5-Year Treasuries.  If inflation is greater than investors will be paid a higher amount of return as the yield is adjusted for inflation.  Maybe not such a great deal for the U.S. taxpayers.

Essentially the heavy buying on the 5-year TIPS means investors feel inflation will increase and get paid by the U.S. Treasury because of the inflation that is being created by the Fed as it tries to prop up the economy and keep interest rates low, including the rates paid by the Treasury for the money it borrows.

It seems like a government Ponzi scheme. The Fed pumps excess money into the economy and buys U.S. debt (QE2, or Quantitative Easing).  The excess money is inflationary and causes prices to rise.  The Treasury issues securities that pay more if inflation rises.  Because one segment of the government is causing inflation and buying debt from another portion of the government, the portion of the government that issues debt is guaranteeing investors higher payout for the debt as a result of the inflation created by the other portion of the government that is allowing the debt to be issued by purchasing it.  Confused?  The U.S. taxpayer won't in 2016 when faced with the interest and principal due payments.

What it amounts to is that a portion of our current $14.5 trillion debt is being financed with yields guaranteed to increase, thereby increasing future debt to pay the current debt, due to inflation that is in part created by the spending causing the $14.5 trillion debt.

On a positive note for some all this is good for MBS which have risen to five week highs and sustained their high trading prices for several days.  

Mortgage rates continue to remain low for the time being.  Call or email Dennis today to determine your purchasing power for a new home loan or monthly savings from a refinance.  Direct dial 562-472-1118