WEBVTT - Why Mortgage Rates Went Up After the Fed's Big Cut 0:00:00.240 --> 0:00:03.240 Hey, Odd Blots listeners, Joe and I have something very 0:00:03.400 --> 0:00:05.800 exciting to share with you. We are going to be 0:00:05.840 --> 0:00:09.560 hosting a live recording of the podcast on the Lower 0:00:09.560 --> 0:00:13.200 East Side of New York at Caveat. We're doing it 0:00:13.240 --> 0:00:16.880 on November fourth, That is, of course, the night before 0:00:17.040 --> 0:00:21.560 the big US election, So join us for an evening 0:00:21.800 --> 0:00:26.360 of policy, discussion, trade, all that good stuff. We're going 0:00:26.440 --> 0:00:30.720 to be hosting Brad Setzer from the Council on Foreign Relations, 0:00:30.920 --> 0:00:34.440 and we'll also have some surprise guests for you as well. 0:00:34.600 --> 0:00:37.640 So you can find the link to buy tickets in 0:00:37.760 --> 0:00:42.320 our new daily Audlots newsletter or on social media, where 0:00:42.479 --> 0:00:44.519 no doubt Joe and I will be talking about it 0:00:44.640 --> 0:00:48.560 a lot, so definitely come join us November fourth at 0:00:48.640 --> 0:00:50.760 Caveat on the Lower east Side. 0:00:52.800 --> 0:01:06.920 Bloomberg Audio Studios, Podcasts, Radio News. 0:01:09.040 --> 0:01:12.440 Hello and welcome to another episode of the Odd Lots Podcast. 0:01:12.520 --> 0:01:14.000 I'm Tracy Allaway. 0:01:13.640 --> 0:01:14.839 And I'm Joe Wisenthal. 0:01:15.400 --> 0:01:17.920 Joe, have you noticed mortgage rates recently? 0:01:18.120 --> 0:01:22.119 Yeah, they've been up. In fact, we're recording this October sixteenth, 0:01:22.520 --> 0:01:25.120 mortgage rates have been rising and in the last couple 0:01:25.160 --> 0:01:28.039 of weeks, mortgage applications according to new data out today, 0:01:28.040 --> 0:01:32.240 have been down, REFI applications have been down, and of 0:01:32.280 --> 0:01:34.280 course it's all ironic because we got that rate cut. 0:01:34.400 --> 0:01:37.880 Yeah, that's right. So benchmark rates have been cut by 0:01:38.080 --> 0:01:41.959 fifty basis points, so we've moved to like five percent 0:01:42.120 --> 0:01:44.640 from the five point five percent on the upper bound 0:01:45.120 --> 0:01:49.320 that happened on September eighteenth. But since then, as you 0:01:49.400 --> 0:01:52.720 point out, mortgage rates have actually gone up. So I 0:01:52.720 --> 0:01:55.600 think we've moved from like six point six percent on 0:01:55.640 --> 0:01:58.760 the thirty year to something like six point nine percent 0:01:59.160 --> 0:02:01.680 as we're recording the we were very close to seven 0:02:01.760 --> 0:02:06.320 percent last week, and just intuitively, that is not what 0:02:06.360 --> 0:02:10.000 you would expect to see happen when benchmark rates are 0:02:10.000 --> 0:02:10.640 getting cut. 0:02:10.880 --> 0:02:15.080 All right, I don't want to ever insult fellow colleague, 0:02:15.200 --> 0:02:17.520 or not colleagues, but other people in the media and 0:02:17.560 --> 0:02:20.600 actually have no basis for this. But in my mind, 0:02:21.280 --> 0:02:23.600 there are a bunch of explainers out there on the internet, 0:02:23.680 --> 0:02:25.639 is like, what do FED rate cuts mean for you? 0:02:25.840 --> 0:02:28.080 And someone put a bullet in there that said, oh, 0:02:28.160 --> 0:02:30.880 they mean lower mortgage rates and stuff like that, And 0:02:31.240 --> 0:02:36.000 obviously there's a connection between FED rates and what people 0:02:36.000 --> 0:02:37.960 pay for a thirty year fixed rate mortgage or some 0:02:38.000 --> 0:02:41.840 other flavor of mortgage. But it's clearly not there's reasons 0:02:41.840 --> 0:02:44.760 why it's not one to one, and there's nothing mechanical 0:02:44.919 --> 0:02:47.960 about the day the FED cuts rates that suddenly borrowing 0:02:48.080 --> 0:02:49.960 costs for homeowners drop. 0:02:50.200 --> 0:02:52.160 Yeah, that's right. And this actually came up in our 0:02:52.240 --> 0:02:56.360 interview with Chicago Fed President Austin Goolsby talking about what 0:02:56.520 --> 0:02:59.720 is the impact of rate cuts on the overall economy 0:02:59.760 --> 0:03:02.280 and talked about how everyone has a fixed rate mortgage 0:03:02.280 --> 0:03:05.680 now and so that doesn't necessarily feed through, but I 0:03:05.680 --> 0:03:10.720 guess it does pose some existential questions for monetary policy transmission. 0:03:10.919 --> 0:03:14.440 Like if the benchmark rate was a person, it would 0:03:14.480 --> 0:03:18.200 be that guy like pointing at himself in the mirror, 0:03:18.560 --> 0:03:22.600 criticizing his own irrelevance. I guess anyway, interesting, that's interesting. 0:03:22.760 --> 0:03:24.800 I wasn't sure we were going with it, but that's interesting. 0:03:25.160 --> 0:03:26.920 That's just what springs to mind. 0:03:27.120 --> 0:03:28.720 You know what I don't get. I mean, I kind 0:03:28.720 --> 0:03:30.840 of get it because we've done episodes on mortgages, but 0:03:30.919 --> 0:03:33.360 like most mortgages in this country are backed by the 0:03:33.440 --> 0:03:36.960 US government or Fany and Freddy implicitly and now more 0:03:37.040 --> 0:03:39.760 or less explicitly like, why can't we all just get 0:03:39.760 --> 0:03:42.200 mortgages at like the ten year rate for the thirty rate? 0:03:42.360 --> 0:03:44.880 You know, Like, seriously, if the government can borrow at 0:03:44.880 --> 0:03:46.840 the thirty or rate and the government is backstopping it, 0:03:46.840 --> 0:03:49.200 why don't we just all get those same prices for 0:03:49.240 --> 0:03:52.240 a mortgage. I know there's reasons, but still I'm not 0:03:52.520 --> 0:03:53.960 I need to be reminded what they are. 0:03:54.160 --> 0:03:56.960 Okay, So this episode is going to be all about 0:03:56.960 --> 0:04:00.120 why Joe can't get a mortgage at four percent a 0:04:00.360 --> 0:04:02.560 ten year rate. We are going to answer that question, 0:04:02.640 --> 0:04:04.600 and I'm very happy to say we do, in fact 0:04:04.680 --> 0:04:07.200 have the perfect guest for this episode. We're going to 0:04:07.240 --> 0:04:10.920 be speaking with Tom Graff. He is the CIO of Facet, 0:04:11.000 --> 0:04:14.920 which is a financial planning firm currently has four billion 0:04:14.960 --> 0:04:19.159 dollars under management. But perhaps more importantly for the subject, 0:04:19.360 --> 0:04:23.039 he was a bond portfolio manager for many, many years, 0:04:23.240 --> 0:04:27.400 and when he started out in finance, he was actually 0:04:27.520 --> 0:04:31.159 in mortgage bond. So he's gonna walk us through the 0:04:31.200 --> 0:04:35.040 sort of mortgage bond ecosystem and all the maths that 0:04:35.160 --> 0:04:37.719 goes into producing the final rate. 0:04:38.080 --> 0:04:40.719 I can't wait. I followed Tom on Twitter for a 0:04:40.720 --> 0:04:42.560 long time. One of my favorite follows, so I'm really 0:04:42.600 --> 0:04:43.440 excited to actra pt. 0:04:43.560 --> 0:04:46.039 Yeah, we finally got him on. Perfect guest for the 0:04:46.120 --> 0:04:48.480 perfect topic. Okay, Tom, thank you so much for coming 0:04:48.480 --> 0:04:49.520 on a lots. 0:04:49.160 --> 0:04:50.719 Thanks for having me, guys, big fan of the show. 0:04:50.760 --> 0:04:51.599 Glad to finally be on. 0:04:52.040 --> 0:04:54.240 So I kind of alluded to it in the intro, 0:04:54.360 --> 0:04:57.760 But why don't you give us a rundown of your expertise? 0:04:58.160 --> 0:04:58.960 Why are we talking to you? 0:04:59.080 --> 0:05:02.800 Yeah, securities and yeah, So, as you mentioned, my first 0:05:02.880 --> 0:05:06.120 job as analyst, I was a mortgage bond analyst, so 0:05:06.520 --> 0:05:09.320 traded mortgages, analyzed mortgage decided what went in the portfolio, 0:05:09.320 --> 0:05:11.760 that sort of thing. Then I graduated being a portfolio 0:05:11.760 --> 0:05:14.200 manager and I ran a general bond fund but also 0:05:14.320 --> 0:05:16.920 ran a mortgage specific fund which was a five star 0:05:16.960 --> 0:05:20.080 fund for a while. And now I'm at FACET. I'm 0:05:20.360 --> 0:05:24.080 I'm the chief investment officer. I oversee all things investment, 0:05:24.200 --> 0:05:26.320 but as a planning firm, we're on the other side. 0:05:26.360 --> 0:05:28.480 Now we're helping people decide, well, it's now the right 0:05:28.520 --> 0:05:30.479 time to refinance, now the right time to buy a house, 0:05:30.920 --> 0:05:33.760 that sort of thing. So I've kind of seen mortgages 0:05:33.800 --> 0:05:35.960 from all angles and I've been at this twenty five years, 0:05:36.000 --> 0:05:37.679 so I've seen a lot happen over that time. 0:05:37.960 --> 0:05:41.040 So we're gonna really dive deep into this. But big picture, 0:05:41.240 --> 0:05:43.479 I actually I don't want to get too much into 0:05:43.520 --> 0:05:46.839 the details on the podcast, but I actually have to 0:05:47.040 --> 0:05:50.040 refinance a mortgage in a couple of years. I could 0:05:50.040 --> 0:05:51.640 do it today, I guess, but I have to do 0:05:51.680 --> 0:05:55.000 it at some point. All right, government thirty year yields 0:05:55.120 --> 0:05:57.360 are four point three percent four point three to two 0:05:57.360 --> 0:05:59.840 percent as we're talking right now. I'll probably want to 0:05:59.839 --> 0:06:02.200 get a thirty year fixed. Why can't I just borrow 0:06:02.200 --> 0:06:04.040 at four point three two percent if the government is 0:06:04.080 --> 0:06:04.919 already backstopping. 0:06:05.360 --> 0:06:08.800 Well, So, the key difference between a mortgage bond and 0:06:08.839 --> 0:06:12.159 a treasury bond is that in the United States, virtually 0:06:12.200 --> 0:06:14.960 all mortgages, and all the ones that Fannie Maine frendimack back, 0:06:15.080 --> 0:06:17.800 can be refinanced at any time without any penalty. 0:06:17.960 --> 0:06:19.920 Can I just promise not to, I guess, because I 0:06:19.960 --> 0:06:21.320 can always sell the house or something like that. 0:06:21.480 --> 0:06:23.760 Yeah, yeah, you can't do that, Joe. And so from 0:06:23.800 --> 0:06:27.480 an investor perspective, right, what that means is if interest 0:06:27.560 --> 0:06:31.000 rates rise, no one refinances. Everyone just stays where they are. 0:06:31.200 --> 0:06:33.560 Witness all the people kind of stuck in two and 0:06:33.600 --> 0:06:35.760 a half three percent mortgages right now, right, and so 0:06:35.800 --> 0:06:38.120 those mortgages just stay outstanding, and they might stay out 0:06:38.160 --> 0:06:40.440 standing for thirty years for all we know, right, Whereas 0:06:40.440 --> 0:06:43.200 if interest rates fall, you kind of don't get any 0:06:43.240 --> 0:06:44.720 of the benefits. So if I buy a thirty year 0:06:44.720 --> 0:06:47.279 treasury and interest rates drop, I could make ten, fifteen 0:06:47.279 --> 0:06:51.080 to twenty percent price appreciation as that happens. But in 0:06:51.120 --> 0:06:54.400 a mortgage bond, if interest rates fall, every just refinances. 0:06:54.480 --> 0:06:56.240 I just get all my money back at par I'm 0:06:56.279 --> 0:06:58.640 no better off. And so you got to get paid 0:06:59.240 --> 0:07:01.640 for that what we'll get into it, but what's called 0:07:01.640 --> 0:07:04.119 negative condexity. You've got to get paid for that risk. 0:07:04.480 --> 0:07:07.280 And that's why there's a spread between mortgage bonds and 0:07:07.279 --> 0:07:07.839 treasury bonds. 0:07:07.920 --> 0:07:09.280 That was perfect, I get it now. 0:07:09.720 --> 0:07:12.640 So who is actually buying mortgage bonds? Because I think 0:07:12.640 --> 0:07:16.120 this is going to feed into the discussion of the 0:07:16.200 --> 0:07:19.600 spread the yield difference between the tenure and something like 0:07:19.640 --> 0:07:22.240 the thirty year mortgage rate. Who's buying? 0:07:22.680 --> 0:07:25.080 Yeah, So it's kind of everybody that plays in the 0:07:25.080 --> 0:07:28.440 bond market, but particularly those that play in the high 0:07:28.560 --> 0:07:31.720 high quality part. So, as you mentioned, Joe, this whole 0:07:31.760 --> 0:07:34.520 market is more or less government backed, and so kind 0:07:34.520 --> 0:07:36.320 of the same buyers we're buying a lot of treasury 0:07:36.320 --> 0:07:38.680 bonds are probably buying a lot of mortgage bonds, So 0:07:39.200 --> 0:07:42.520 that particularly goes to banks and financial institutions. They get 0:07:42.920 --> 0:07:45.800 favorable capital treatment versus corporate bonds or something else, so 0:07:45.800 --> 0:07:48.520 it's kind of the highest yielding thing they can buy 0:07:48.560 --> 0:07:51.560 that has good capital treatment. And then money managers are 0:07:51.600 --> 0:07:54.880 certainly buying, particularly ones that are focused on kind of 0:07:54.880 --> 0:07:57.960 a general bond benchmarket. It's about thirty percent of the 0:07:57.960 --> 0:08:00.920 Bloomberg aggregate. And then you also have a lot of 0:08:00.920 --> 0:08:03.480 mortgage rates, so it's an acid that's easy to leverage, 0:08:03.880 --> 0:08:05.440 and so there's a lot of players there as well. 0:08:05.800 --> 0:08:11.400 Tracy, I heard a rumor, and I can't say any 0:08:11.520 --> 0:08:13.720 I'm going to be very vague about this, but I 0:08:13.800 --> 0:08:15.880 recently heard a rumor that there was some sort of 0:08:15.920 --> 0:08:18.040 a meeting and there were a lot of economists there, 0:08:18.280 --> 0:08:21.000 and I can't say any more details about what it was, 0:08:21.360 --> 0:08:24.800 but that actually there is still a widespread misconception, even 0:08:24.840 --> 0:08:28.960 among professionals who should know, this perception that banks have 0:08:28.960 --> 0:08:31.040 gotten out of the mortgage space that after two thousand 0:08:31.040 --> 0:08:32.680 and eight, two thousand and nine, it all sort of 0:08:32.720 --> 0:08:35.800 went to what you know, people call non bank lenders 0:08:35.920 --> 0:08:39.160 or other asset managers, et cetera. But banks, according to 0:08:39.160 --> 0:08:41.920 what you're saying, are still huge holders of mortgages. And 0:08:41.920 --> 0:08:43.840 then I guess what's going on with bank balance sheets 0:08:43.840 --> 0:08:44.880 et cetera? Really do match? 0:08:44.920 --> 0:08:46.920 Joe? That is so cryptic. You make it sound like 0:08:46.920 --> 0:08:50.000 you were at Builderberg or something like some big, top 0:08:50.040 --> 0:08:50.720 secret meeting. 0:08:51.360 --> 0:08:54.160 I'm not going to say anymore. This was third hand. Well, 0:08:54.200 --> 0:08:56.520 it's an answer you question. I'm not going to insulting anyone. 0:08:56.600 --> 0:08:58.560 No one can hear this and oh this was me, 0:08:58.679 --> 0:09:00.320 But I'll tell you that I. 0:09:00.320 --> 0:09:02.480 Don't know what Yeah, no one, with no comment on 0:09:02.520 --> 0:09:05.440 what Joe might be getting into in his off hours. Yeah. Look, 0:09:05.520 --> 0:09:08.040 I think banks have always been big players. Now the 0:09:08.120 --> 0:09:12.240 degree to which they buy depends on a lot of things. 0:09:12.320 --> 0:09:15.000 So what else could they do with that capital? Is 0:09:15.000 --> 0:09:17.600 there are more efficient ways to use that capital, And 0:09:17.640 --> 0:09:20.680 in particular right now, the fact that the yield curve 0:09:20.720 --> 0:09:23.600 is so flat does make it a little tricky. Right, 0:09:23.720 --> 0:09:27.360 So banks their whole game is get in capital at 0:09:27.440 --> 0:09:29.520 deposit rates, right, and you guys have done a couple 0:09:29.559 --> 0:09:32.160 of shows on how deposit rates have been rising. And 0:09:32.200 --> 0:09:35.520 then buy something, you know, whether it's lending or securities 0:09:35.559 --> 0:09:38.240 that yield more, and the closer those are, the less 0:09:38.280 --> 0:09:40.960 that makes sense, and mortgages there's higher yielding things they 0:09:41.000 --> 0:09:43.839 could do. So making a normal commercial and industrial loan 0:09:43.960 --> 0:09:45.240 is going to have a higher yield. And so I 0:09:45.240 --> 0:09:47.640 think it a flatter curve, just a little trickier for 0:09:47.679 --> 0:09:50.920 banks be big buyers. But still in the scheme of things, 0:09:50.960 --> 0:09:53.120 there's still big players in the mortgage market for sure. 0:09:53.480 --> 0:09:57.600 So talk to us about what goes into producing a 0:09:57.679 --> 0:09:59.920 mortgage rate. So if I want to buy a house, 0:10:00.120 --> 0:10:01.720 and I go to a bank and I ask for 0:10:01.800 --> 0:10:05.360 a mortgage, what are the individual factors that go into 0:10:05.440 --> 0:10:07.760 the number that eventually gets quoted back to me? 0:10:07.920 --> 0:10:10.960 Okay, Yeah, So let's assume for sake of argument, this 0:10:11.080 --> 0:10:14.200 is alone that conforms to Fanny and Freddy's standards, because 0:10:14.200 --> 0:10:17.400 that's the ones we're talking about here. Okay, So assuming that, right, 0:10:18.080 --> 0:10:22.400 your bank has to pay Fanny or Freddy a guarantee fee. Okay, 0:10:22.480 --> 0:10:26.160 So that is gfee, the GFI exactly, and that is 0:10:26.280 --> 0:10:30.160 based on your credit situation, so how much you're putting down, 0:10:30.200 --> 0:10:33.360 what your credit score is, that sort of thing. But 0:10:33.400 --> 0:10:35.440 it's all algorithmics, so they're just typing into a computer 0:10:35.520 --> 0:10:38.760 or fanning Freddy's kicking back, here's the rate. Right. Then 0:10:38.760 --> 0:10:41.000 they're also going to think to themselves, okay, well where 0:10:41.000 --> 0:10:42.079 can I sell this mortgage? 0:10:42.160 --> 0:10:42.280 Right? 0:10:42.280 --> 0:10:44.080 What price am I going to get when I sell 0:10:44.080 --> 0:10:47.800 it in the open market? And that depends mostly on 0:10:48.120 --> 0:10:50.360 just what the general price is for the going rate 0:10:50.400 --> 0:10:53.200 for mortgages, but it might depend a little on your situation. 0:10:53.360 --> 0:10:56.079 So we can get into it how certain kinds of 0:10:56.160 --> 0:10:58.360 mortgages command a bit more of a premium in the 0:10:58.400 --> 0:11:00.920 market than others, and that will go in to the 0:11:01.040 --> 0:11:03.920 rate you're gonna get quoted. And so every night the 0:11:03.960 --> 0:11:07.040 bank's mortgage desk is sort of plugging in, hey for more. 0:11:07.080 --> 0:11:09.080 It's like this, we'll offer this rate from words like that, 0:11:09.080 --> 0:11:11.520 we're off this right, and all these factors are going 0:11:11.559 --> 0:11:13.920 into that. So when your loan officers typing this into 0:11:13.960 --> 0:11:16.560 his computer, that's what's spitting out right. 0:11:17.360 --> 0:11:21.040 Actually, let's back up what makes a mortgage conforming versus 0:11:21.080 --> 0:11:21.680 non conforming. 0:11:22.040 --> 0:11:23.959 The biggest thing is the price. Okay, So the price 0:11:24.080 --> 0:11:26.880 relative to used to be a hard number, but now 0:11:27.040 --> 0:11:29.680 Fanny and Freddy do it relative to your sort of 0:11:29.760 --> 0:11:31.760 MSA or your area. 0:11:31.840 --> 0:11:34.560 So wait, above a certain price, can you go into 0:11:34.600 --> 0:11:36.400 that a little further above a certain price? Fanny and 0:11:36.440 --> 0:11:37.160 Freddy just want. 0:11:37.240 --> 0:11:38.760 Yeah, they're just not backing it, and that has to 0:11:38.760 --> 0:11:41.680 do with their mandate from Congress to be about affordable housing. 0:11:41.840 --> 0:11:42.679 God, yeah, got. 0:11:57.920 --> 0:12:00.120 So you outlined what happens when we go to a 0:12:00.160 --> 0:12:03.160 bank and we get a mortgage. What happens in the 0:12:03.200 --> 0:12:07.360 sales process, So that mortgage eventually gets sold on the 0:12:07.400 --> 0:12:10.360 open market. As you said, how does it get sold? 0:12:10.480 --> 0:12:13.600 Right? So, the bank's going to pool together a number 0:12:13.600 --> 0:12:15.840 of mortgages, and by a number, I mean kind of 0:12:15.880 --> 0:12:18.400 any number. You can have a dozen mortgages in a pool. 0:12:18.720 --> 0:12:21.040 You could have one hundred thousand mortgages in a pool. 0:12:21.120 --> 0:12:23.920 And so they'll but they'll pull them together. What they're 0:12:23.920 --> 0:12:25.760 going to try to do is just get best execution, 0:12:25.880 --> 0:12:28.880 like any other trade that you do in any other market. Right, 0:12:28.920 --> 0:12:30.640 And the way they're going to get best execution is 0:12:30.679 --> 0:12:35.280 by grouping the loans together that command a premium. All right, 0:12:35.320 --> 0:12:37.760 So let me give it for instance, it is apropos 0:12:38.080 --> 0:12:42.240 to Joe's refinancing situation. If you're in New York, if 0:12:42.280 --> 0:12:44.960 you have a pool that's all New York loans, that's 0:12:44.960 --> 0:12:47.080 going to get a premium. And the reason is because 0:12:47.120 --> 0:12:51.160 in New York, this transfer tax makes refinancing more expensive 0:12:51.320 --> 0:12:55.079 for a New Yorker. So New York loans refinanced slower 0:12:55.120 --> 0:12:57.360 than all the other loans. And so what we call 0:12:57.400 --> 0:13:01.000 that in the mortgage business call protection. So if for 0:13:01.080 --> 0:13:03.800 every basis point decline in rates, a New York loan 0:13:03.880 --> 0:13:06.079 is gonna pay a little slower, and that tends to 0:13:06.080 --> 0:13:08.400 be advantageous to the investors. So they're gonna take all 0:13:08.679 --> 0:13:12.480 If they've got thirty New York loans and thirty Oklahoma loans, 0:13:12.600 --> 0:13:14.480 they're not gonna pull them together because that would waste 0:13:14.480 --> 0:13:16.040 their money. They're gonna put all the New York loans 0:13:16.040 --> 0:13:18.640 in one loan and get a premium for those, and 0:13:18.720 --> 0:13:21.240 just sell all of the Oklahoma ones at the at 0:13:21.280 --> 0:13:22.559 the kind of generic. 0:13:22.200 --> 0:13:24.800 Right, that's interesting. So if I'm a buyer, I pay 0:13:24.840 --> 0:13:27.040 a little bit more for New York loans because of 0:13:27.040 --> 0:13:30.200 that less sensitivity the REFI you know, I was thinking, 0:13:30.480 --> 0:13:33.560 so again, I'm not trying to get too into my 0:13:34.040 --> 0:13:38.640 personal finances, but I remember around twenty twenty three and 0:13:38.800 --> 0:13:41.439 mortgage rates hit eight percent, and a lot of things 0:13:41.480 --> 0:13:44.120 that people were saying, including like mortgage brokers you call 0:13:44.160 --> 0:13:46.320 you on the phone or whatever right after you enter 0:13:46.360 --> 0:13:49.319 into some website like oh, don't worry about the high rates. 0:13:49.520 --> 0:13:51.760 You just refinanced in a few years. And I you know, 0:13:51.880 --> 0:13:55.560 I'm very emh brained. So I'm thinking like, well, if 0:13:55.600 --> 0:13:59.079 everyone is already planning on refinancing in a few years, 0:13:59.120 --> 0:14:02.280 then there probably is going to be the great refinance opportunity, 0:14:02.280 --> 0:14:05.720 because not everyone can just take that free lunch, you know, 0:14:05.760 --> 0:14:07.520 when it is eight percent and everyone's like, yeah, I'm 0:14:07.559 --> 0:14:09.440 just going to refinance though in a few years, so 0:14:09.559 --> 0:14:13.120 it'll be fine. Does that sort of like factor into 0:14:13.160 --> 0:14:15.600 the mouth of how much premium the buyer demand? 0:14:15.880 --> 0:14:17.800 Yeah? I think it really did. And let me give 0:14:17.840 --> 0:14:23.200 a very specific example. So right now, the spread between 0:14:23.400 --> 0:14:26.640 the tenure Treasury and the mortgage rate is relatively large, 0:14:26.840 --> 0:14:28.680 and I'm talking about the investor rate and I'm talking 0:14:28.680 --> 0:14:31.240 about the actual borrow rate you get at the bank, 0:14:31.400 --> 0:14:33.920 right and so there's a lot of discussion as to 0:14:33.920 --> 0:14:35.920 why is that right, And it's been pretty sticky. It's 0:14:36.000 --> 0:14:38.800 it's stayed unusually wide for a couple of years now, 0:14:39.200 --> 0:14:41.000 and I think one of the reasons is what I 0:14:41.000 --> 0:14:44.680 would call severe negative convexity. So negative convexity is this 0:14:44.800 --> 0:14:47.560 idea I said earlier, where boy, if interest rates rise, 0:14:47.760 --> 0:14:49.760 I don't really get any benefit from buying mortgages, but 0:14:49.800 --> 0:14:52.520 if instrates fall, I don't get any upside either, right, 0:14:52.560 --> 0:14:55.040 So that's this idea of negative vexity. Well, if you 0:14:55.120 --> 0:15:01.840 have everybody laser focused on REFI opportunity, right, maybe the 0:15:01.920 --> 0:15:04.680 kinds of people who never check on interest rates, right, 0:15:04.800 --> 0:15:06.920 but all of a sudden they're like, I'm checking every day. 0:15:06.920 --> 0:15:09.480 I want to know the moment if they're laser focused 0:15:09.520 --> 0:15:12.360 on that and the moment they have any opportunity, they're 0:15:12.360 --> 0:15:14.760 going to be right on it. Right. Well, that's a 0:15:14.800 --> 0:15:17.760 different kind of negative condexity. I'm going to take my 0:15:17.880 --> 0:15:20.600 bond that I own is going to refive faster than 0:15:20.600 --> 0:15:22.480 it might otherwise at a time that people on mayor 0:15:22.680 --> 0:15:24.640 may or may not be paying attention. Right. So, as 0:15:24.640 --> 0:15:28.200 an investor, you just mentioned your your efficient markets billed. Yeah, 0:15:28.240 --> 0:15:32.080 as an investor, I'm not unaware of that. Right, I'm thinking, boy, 0:15:32.200 --> 0:15:33.760 these things are going to pay like a bat out 0:15:33.760 --> 0:15:36.760 of hell the moment interest rates drop even a little 0:15:36.920 --> 0:15:38.920 and I need to get paid a little more for that. 0:15:39.360 --> 0:15:43.320 Tracy. By the way, you and listeners right now should 0:15:43.320 --> 0:15:45.840 go to Google Trends and look for a search of 0:15:45.880 --> 0:15:48.480 the word no. Seriously is a great charge. Someone had 0:15:48.520 --> 0:15:49.640 showed to me this a few. 0:15:49.480 --> 0:15:51.040 Weeks discussing line goes up. 0:15:51.280 --> 0:15:53.640 Look at the word Do a Google Trends search for 0:15:53.680 --> 0:15:56.920 the word refinancing, and you will see a big spike 0:15:57.160 --> 0:16:00.440 on September eighteenth because it was you know, not everyone's 0:16:00.440 --> 0:16:03.120 always paying attention to rates, But there's like one day 0:16:03.160 --> 0:16:06.400 this year where the Fed actually made some pretty significant 0:16:06.400 --> 0:16:08.840 news that sort of broke through the bubble, and you 0:16:08.880 --> 0:16:10.840 could see how suddenly there were a bunch of people 0:16:11.000 --> 0:16:13.440 paying attention to rates. Ironically, they didn't get any real 0:16:13.480 --> 0:16:17.200 benefits automatically, but you could see how people don't pay attention. 0:16:17.320 --> 0:16:19.200 And then there's a day when someday they were. 0:16:19.600 --> 0:16:23.240 The futility of doing Google research. Everyone wants to refile 0:16:23.280 --> 0:16:25.480 on that specific date and they can't get a lower 0:16:25.600 --> 0:16:28.520 rate anyway. Tom I wanted to ask, what is the 0:16:28.720 --> 0:16:33.880 ideal environment to be buying mortgages in because I think 0:16:33.920 --> 0:16:36.720 back to the years after two thousand and eight when 0:16:36.800 --> 0:16:40.280 interest rates were really low, and I remember big investors 0:16:40.400 --> 0:16:43.880 in mbs. They always complained, you know, they didn't want 0:16:43.920 --> 0:16:46.480 to get prepaid because then they would have all this 0:16:46.560 --> 0:16:50.040 extra money that they would have to reinvest at lower rates. 0:16:50.320 --> 0:16:53.400 But now we're in the higher rate environment and they're 0:16:53.400 --> 0:16:57.000 also complaining, So like, what is the ideal here? 0:16:57.280 --> 0:17:02.280 Yeah, So one way to think about mortgage investing is 0:17:02.720 --> 0:17:05.359 and I'm going to play on another odd lots theme here, please, 0:17:06.320 --> 0:17:09.199 It's a little like doing a covered call strategy in 0:17:09.240 --> 0:17:11.680 a stock all right. So what I've kind of done 0:17:11.800 --> 0:17:14.440 is I bought a bond and I've also sold an 0:17:14.480 --> 0:17:17.560 option to the borrower, and that option is to call 0:17:17.600 --> 0:17:20.240 my bond away, right. And it's just like if I 0:17:20.240 --> 0:17:23.800 buy Microsoft and I sell an option for someone to 0:17:23.800 --> 0:17:26.440 buy Microsoft from me. It's exactly the same trade. And 0:17:26.480 --> 0:17:29.399 if you think about that trade, right, what you want 0:17:29.520 --> 0:17:32.240 is for Microsoft to do nothing, because if it goes down, 0:17:32.440 --> 0:17:35.240 I've lost money. If it goes up, I get called away, right, 0:17:35.280 --> 0:17:37.720 But if it does nothing, I just collect that premium 0:17:37.880 --> 0:17:40.199 and I still have my stock. Right, So what you 0:17:40.320 --> 0:17:45.040 want is for interest rates to stay very steady. Okay, 0:17:45.080 --> 0:17:47.800 and nobody really gets to refinance. But I don't suffer 0:17:47.840 --> 0:17:51.159 the downside that I suffer if interest rates rise, and 0:17:51.200 --> 0:17:54.080 so mortgage is it's a tough It can be a 0:17:54.119 --> 0:17:57.040 tough total return bond. So like if you think about 0:17:57.359 --> 0:18:00.480 someone trying to trade it and play interest rates move around, 0:18:00.680 --> 0:18:02.320 that's not that great. What it is is a good 0:18:02.400 --> 0:18:04.959 income bond. So I buy it to collect this income. 0:18:05.000 --> 0:18:07.080 If interust rates can stay steady, it can be a 0:18:07.119 --> 0:18:07.960 great bond to own. 0:18:08.240 --> 0:18:10.639 And this is why people call them pass throughs, right. 0:18:10.720 --> 0:18:13.760 Well, yeah, passive. The other thing people will say is 0:18:13.840 --> 0:18:16.159 it can be a good defensive bond. So if you 0:18:16.320 --> 0:18:20.080 think that corporate bonds are going to suffer because there's 0:18:20.119 --> 0:18:21.719 gonna be a recession, a lot of times people will 0:18:21.800 --> 0:18:25.280 rotate into mortgage bonds because they're still yield there and 0:18:25.520 --> 0:18:27.479 they're not as sensitive to that part of the cycle. 0:18:27.920 --> 0:18:30.000 Usually when that happens, interest rates drop a lot and 0:18:30.040 --> 0:18:31.840 you're not getting that upside and so I don't know, 0:18:32.280 --> 0:18:34.080 there's a tough space. It's a tough space. 0:18:34.400 --> 0:18:37.919 Do Americans under refinance? I mean there must be some 0:18:37.960 --> 0:18:40.159 population that doesn't pay attention. So I'm looking at you know, 0:18:40.160 --> 0:18:44.200 mortgage rates in twenty ten, at one point December thirty first, 0:18:44.280 --> 0:18:46.359 twenty ten, they're at four point nine to nine percent. 0:18:47.000 --> 0:18:50.880 They had gotten as low in twenty sixteen at three 0:18:50.920 --> 0:18:53.760 point three percent. You know, I imagine in your covered 0:18:53.800 --> 0:18:57.400 call strategy, anyone engaging in these things are very sophisticated 0:18:57.440 --> 0:18:59.960 and you call it right away. Is there an advance 0:19:00.320 --> 0:19:02.720 for mortgage buyers sort of taking advantage of the fact 0:19:02.720 --> 0:19:06.480 that the counterparty to this trade is not watching rates 0:19:06.520 --> 0:19:06.920 all day? 0:19:07.040 --> 0:19:10.000 No, for sure, that is true. So this concept in 0:19:10.040 --> 0:19:12.760 mortgage trading called burnout, okay, and this is the idea 0:19:13.000 --> 0:19:15.800 that at a certain point everyone who's going to refinance 0:19:15.880 --> 0:19:18.920 has refinanced. Yeah, So if we rewind to twenty twenty, 0:19:19.040 --> 0:19:21.440 twenty twenty one, r ine traates were really low, you'd 0:19:21.480 --> 0:19:24.720 still see five percent mortgages outstanding, and you'd be like, well, 0:19:24.720 --> 0:19:25.840 why what are they doing? 0:19:26.720 --> 0:19:28.560