The spread of COVID-19 has caused disruptions in the financial and economic markets. However, the Joint Center for Housing Studies of Harvard University looked at how the stresses facing the market could impact the housing industry.
Don Layton, the former CEO of Freddie Mac and the author of the piece, said many REITs specialize in mortgage-related assets, ranging from liquidized agency-mortgage backed securities or commercial MBS and other real-estate debt models.
“They are hedge funds in most respects, relying on high leverage (secured by their assets) to produce good returns, but leaving them with tremendous liquidity exposure because they need to keep rolling their debt as they invest in long-term assets while financing them with short-term liabilities,” he said.
Layton added that the financial stresses in the current market stem from an “extreme global flight-to-safety” and liquidity, which is resulting in high demand for cash.
“Although agency MBS is government-supported, there is a high spread between the yield on MBS and the equivalent maturity Treasuries,” Layton said. “The agency MBS market has long been regarded as second in size and liquidity only to the market for Treasuries themselves, and so agency MBS investors are rattled.”
Both the Federal Reserve and the U.S. Department of the Treasury announced plans to provide additional liquidity into the economy and support for households to combat the impact of COVID-19.
The Fed added that it would use its “full range of tools” to support households, businesses, and the economy during these uncertain times. It will also purchase Treasury securities and agency mortgage-backed securities “in the amounts needed to support smooth marketing functioning” and transmission of monetary policy.
Last week the Fed announced it would purchase at least $500 billion in Treasury securities and at least $200 billion of mortgage-backed securities. The Federal Housing Finance Agency (FHFA) added that it has authorized Fannie Mae and Freddie Mac to enter into additional dollar-roll transactions—provide mortgage-back securities investors with short-term financing.
Also, a concern for Layton could be the losses suffered by the GSEs. He said, combined, that Fannie Mae and Freddie Mac have about $5 trillion in credit guarantees, mostly in single-family mortgages and securities investments.
While losing large amounts during the Great Recession, Layton said the GSEs have eliminated the major sources of those losses.
“Ideally, their credit reserves should rise—they are, after all, supposed to take appropriate credit risk—but not anything like in the last crisis,” Layton said.