Eighteen years ago this October, long before the Asian and
crises, long before the dot-com implosion, and long before the
2008-2009 financial crisis, I penned this
We can understand losses caused by bad bets on market direction,
but those have surprisingly limited potential for disaster: Barring
a Kidder Peabody or Barings-like breakdown in controls (or someone
willing and able to meet a margin call greater than the firm's
capitalization), there's a limit to just how wrong your clearing
firm will allow you to be.
Instruments like collateralized mortgage obligations (CMOs, the
exploding cigars of the financial world) allowed David Askin to
lose a cool $600 million in a matter of days, but are so obscure
and complex that spectators have to be told that a wreck just
Mortgages still retain their power to unleash pain and suffering on
all involved; there is a reason that the word itself comes from the
Norman French "death pledge." The Normans and their kinspeople now
populating the residual royal families of Western Europe may have
been Vikings with manners, but even before modern financial
alchemists started flavoring everything with nitroglycerin, they
understood there was more to lending against a piece of property
than meets the eye.
Punchbowl Removal Society
Mortgage REITs, the largest of which are
Annaly Capital Management
American Capital Agency
Two Harbors Investment
), were among the intended beneficiaries of QE1 and QE3. Both of
these monetary expansions were executed in large part by the
Federal Reserve buying mortgage-backed securities in an attempt to
drive mortgage rates lower and offset the reticence of lenders to
get back into the residential real estate market.
Let's ignore the
obvious side effect
of this policy, how lower rates were capitalized into housing
prices and therefore reward sellers at the expense of first-time
buyers, and focus instead on mortgage REITs' prospective returns.
Incredibly, mortgage REITs have underperformed the broad REIT index
since March 2009.
Mortgage REITs had been outperforming the S&P 1500
Supercomposite over the QE era rather handily until the end of
April, but have given up virtually all of their performance
advantage since then.
The obvious culprit in this performance downturn has been the
prospective change in US monetary policy. While the Federal Reserve
making it up as it goes along
, everyone knows the next move in interest rates is unlikely to be
lower. The result has been for the yield curve of REIT bonds to
steepen relative to the Treasury yield curve; this means that the
cost of long-term REIT financing now incorporates the very real
possibility that the large, price-insensitive buyer from
Washington, DC, will disappear.
Even as the Federal Reserve has reiterated that no policy changes
are imminent, the yield curve of REIT bonds has not flattened back
to its previous relationship vis-Ã -vis the Treasury yield
curve. Four years of good old-fashioned money-printing went down
the drain and took mortgage REITs with it. As no QE5 is on the
horizon, the group is going to wander in the wilderness for a