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Speaker 1: Hello and welcome to another episode of the Odd Lots Podcast.
Speaker 1: I'm Tracy Allaway.
Speaker 3: And I'm Joe Wisenthal.
Speaker 1: Joe, have you noticed mortgage rates recently?
Speaker 3: Yeah, they've been up. In fact, we're recording this October sixteenth,
Speaker 3: mortgage rates have been rising and in the last couple
Speaker 3: of weeks, mortgage applications according to new data out today,
Speaker 3: have been down, REFI applications have been down, and of
Speaker 3: course it's all ironic because we got that rate cut.
Speaker 1: Yeah, that's right. So benchmark rates have been cut by
Speaker 1: fifty basis points, so we've moved to like five percent
Speaker 1: from the five point five percent on the upper bound
Speaker 1: that happened on September eighteenth. But since then, as you
Speaker 1: point out, mortgage rates have actually gone up. So I
Speaker 1: think we've moved from like six point six percent on
Speaker 1: the thirty year to something like six point nine percent
Speaker 1: as we're recording the we were very close to seven
Speaker 1: percent last week, and just intuitively, that is not what
Speaker 1: you would expect to see happen when benchmark rates are
Speaker 1: getting cut.
Speaker 3: All right, I don't want to ever insult fellow colleague,
Speaker 3: or not colleagues, but other people in the media and
Speaker 3: actually have no basis for this. But in my mind,
Speaker 3: there are a bunch of explainers out there on the internet,
Speaker 3: is like, what do FED rate cuts mean for you?
Speaker 3: And someone put a bullet in there that said, oh,
Speaker 3: they mean lower mortgage rates and stuff like that, And
Speaker 3: obviously there's a connection between FED rates and what people
Speaker 3: pay for a thirty year fixed rate mortgage or some
Speaker 3: other flavor of mortgage. But it's clearly not there's reasons
Speaker 3: why it's not one to one, and there's nothing mechanical
Speaker 3: about the day the FED cuts rates that suddenly borrowing
Speaker 3: costs for homeowners drop.
Speaker 1: Yeah, that's right. And this actually came up in our
Speaker 1: interview with Chicago Fed President Austin Goolsby talking about what
Speaker 1: is the impact of rate cuts on the overall economy
Speaker 1: and talked about how everyone has a fixed rate mortgage
Speaker 1: now and so that doesn't necessarily feed through, but I
Speaker 1: guess it does pose some existential questions for monetary policy transmission.
Speaker 1: Like if the benchmark rate was a person, it would
Speaker 1: be that guy like pointing at himself in the mirror,
Speaker 1: criticizing his own irrelevance. I guess anyway, interesting, that's interesting.
Speaker 3: I wasn't sure we were going with it, but that's interesting.
Speaker 1: That's just what springs to mind.
Speaker 3: You know what I don't get. I mean, I kind
Speaker 3: of get it because we've done episodes on mortgages, but
Speaker 3: like most mortgages in this country are backed by the
Speaker 3: US government or Fany and Freddy implicitly and now more
Speaker 3: or less explicitly like, why can't we all just get
Speaker 3: mortgages at like the ten year rate for the thirty rate?
Speaker 3: You know, Like, seriously, if the government can borrow at
Speaker 3: the thirty or rate and the government is backstopping it,
Speaker 3: why don't we just all get those same prices for
Speaker 3: a mortgage. I know there's reasons, but still I'm not
Speaker 3: I need to be reminded what they are.
Speaker 1: Okay, So this episode is going to be all about
Speaker 1: why Joe can't get a mortgage at four percent a
Speaker 1: ten year rate. We are going to answer that question,
Speaker 1: and I'm very happy to say we do, in fact
Speaker 1: have the perfect guest for this episode. We're going to
Speaker 1: be speaking with Tom Graff. He is the CIO of Facet,
Speaker 1: which is a financial planning firm currently has four billion
Speaker 1: dollars under management. But perhaps more importantly for the subject,
Speaker 1: he was a bond portfolio manager for many, many years,
Speaker 1: and when he started out in finance, he was actually
Speaker 1: in mortgage bond. So he's gonna walk us through the
Speaker 1: sort of mortgage bond ecosystem and all the maths that
Speaker 1: goes into producing the final rate.
Speaker 3: I can't wait. I followed Tom on Twitter for a
Speaker 3: long time. One of my favorite follows, so I'm really
Speaker 3: excited to actra pt.
Speaker 1: Yeah, we finally got him on. Perfect guest for the
Speaker 1: perfect topic. Okay, Tom, thank you so much for coming
Speaker 1: on a lots.
Speaker 4: Thanks for having me, guys, big fan of the show.
Speaker 4: Glad to finally be on.
Speaker 1: So I kind of alluded to it in the intro,
Speaker 1: But why don't you give us a rundown of your expertise?
Speaker 3: Why are we talking to you?
Speaker 4: Yeah, securities and yeah, So, as you mentioned, my first
Speaker 4: job as analyst, I was a mortgage bond analyst, so
Speaker 4: traded mortgages, analyzed mortgage decided what went in the portfolio,
Speaker 4: that sort of thing. Then I graduated being a portfolio
Speaker 4: manager and I ran a general bond fund but also
Speaker 4: ran a mortgage specific fund which was a five star
Speaker 4: fund for a while. And now I'm at FACET. I'm
Speaker 4: I'm the chief investment officer. I oversee all things investment,
Speaker 4: but as a planning firm, we're on the other side.
Speaker 4: Now we're helping people decide, well, it's now the right
Speaker 4: time to refinance, now the right time to buy a house,
Speaker 4: that sort of thing. So I've kind of seen mortgages
Speaker 4: from all angles and I've been at this twenty five years,
Speaker 4: so I've seen a lot happen over that time.
Speaker 3: So we're gonna really dive deep into this. But big picture,
Speaker 3: I actually I don't want to get too much into
Speaker 3: the details on the podcast, but I actually have to
Speaker 3: refinance a mortgage in a couple of years. I could
Speaker 3: do it today, I guess, but I have to do
Speaker 3: it at some point. All right, government thirty year yields
Speaker 3: are four point three percent four point three to two
Speaker 3: percent as we're talking right now. I'll probably want to
Speaker 3: get a thirty year fixed. Why can't I just borrow
Speaker 3: at four point three two percent if the government is
Speaker 3: already backstopping.
Speaker 4: Well, So, the key difference between a mortgage bond and
Speaker 4: a treasury bond is that in the United States, virtually
Speaker 4: all mortgages, and all the ones that Fannie Maine frendimack back,
Speaker 4: can be refinanced at any time without any penalty.
Speaker 3: Can I just promise not to, I guess, because I
Speaker 3: can always sell the house or something like that.
Speaker 4: Yeah, yeah, you can't do that, Joe. And so from
Speaker 4: an investor perspective, right, what that means is if interest
Speaker 4: rates rise, no one refinances. Everyone just stays where they are.
Speaker 4: Witness all the people kind of stuck in two and
Speaker 4: a half three percent mortgages right now, right, and so
Speaker 4: those mortgages just stay outstanding, and they might stay out
Speaker 4: standing for thirty years for all we know, right, Whereas
Speaker 4: if interest rates fall, you kind of don't get any
Speaker 4: of the benefits. So if I buy a thirty year
Speaker 4: treasury and interest rates drop, I could make ten, fifteen
Speaker 4: to twenty percent price appreciation as that happens. But in
Speaker 4: a mortgage bond, if interest rates fall, every just refinances.
Speaker 4: I just get all my money back at par I'm
Speaker 4: no better off. And so you got to get paid
Speaker 4: for that what we'll get into it, but what's called
Speaker 4: negative condexity. You've got to get paid for that risk.
Speaker 4: And that's why there's a spread between mortgage bonds and
Speaker 4: treasury bonds.
Speaker 3: That was perfect, I get it now.
Speaker 1: So who is actually buying mortgage bonds? Because I think
Speaker 1: this is going to feed into the discussion of the
Speaker 1: spread the yield difference between the tenure and something like
Speaker 1: the thirty year mortgage rate. Who's buying?
Speaker 4: Yeah, So it's kind of everybody that plays in the
Speaker 4: bond market, but particularly those that play in the high
Speaker 4: high quality part. So, as you mentioned, Joe, this whole
Speaker 4: market is more or less government backed, and so kind
Speaker 4: of the same buyers we're buying a lot of treasury
Speaker 4: bonds are probably buying a lot of mortgage bonds, So
Speaker 4: that particularly goes to banks and financial institutions. They get
Speaker 4: favorable capital treatment versus corporate bonds or something else, so
Speaker 4: it's kind of the highest yielding thing they can buy
Speaker 4: that has good capital treatment. And then money managers are
Speaker 4: certainly buying, particularly ones that are focused on kind of
Speaker 4: a general bond benchmarket. It's about thirty percent of the
Speaker 4: Bloomberg aggregate. And then you also have a lot of
Speaker 4: mortgage rates, so it's an acid that's easy to leverage,
Speaker 4: and so there's a lot of players there as well.
Speaker 3: Tracy, I heard a rumor, and I can't say any
Speaker 3: I'm going to be very vague about this, but I
Speaker 3: recently heard a rumor that there was some sort of
Speaker 3: a meeting and there were a lot of economists there,
Speaker 3: and I can't say any more details about what it was,
Speaker 3: but that actually there is still a widespread misconception, even
Speaker 3: among professionals who should know, this perception that banks have
Speaker 3: gotten out of the mortgage space that after two thousand
Speaker 3: and eight, two thousand and nine, it all sort of
Speaker 3: went to what you know, people call non bank lenders
Speaker 3: or other asset managers, et cetera. But banks, according to
Speaker 3: what you're saying, are still huge holders of mortgages. And
Speaker 3: then I guess what's going on with bank balance sheets
Speaker 3: et cetera? Really do match?
Speaker 1: Joe? That is so cryptic. You make it sound like
Speaker 1: you were at Builderberg or something like some big, top
Speaker 1: secret meeting.
Speaker 3: I'm not going to say anymore. This was third hand. Well,
Speaker 3: it's an answer you question. I'm not going to insulting anyone.
Speaker 3: No one can hear this and oh this was me,
Speaker 3: But I'll tell you that I.
Speaker 4: Don't know what Yeah, no one, with no comment on
Speaker 4: what Joe might be getting into in his off hours. Yeah. Look,
Speaker 4: I think banks have always been big players. Now the
Speaker 4: degree to which they buy depends on a lot of things.
Speaker 4: So what else could they do with that capital? Is
Speaker 4: there are more efficient ways to use that capital, And
Speaker 4: in particular right now, the fact that the yield curve
Speaker 4: is so flat does make it a little tricky. Right,
Speaker 4: So banks their whole game is get in capital at
Speaker 4: deposit rates, right, and you guys have done a couple
Speaker 4: of shows on how deposit rates have been rising. And
Speaker 4: then buy something, you know, whether it's lending or securities
Speaker 4: that yield more, and the closer those are, the less
Speaker 4: that makes sense, and mortgages there's higher yielding things they
Speaker 4: could do. So making a normal commercial and industrial loan
Speaker 4: is going to have a higher yield. And so I
Speaker 4: think it a flatter curve, just a little trickier for
Speaker 4: banks be big buyers. But still in the scheme of things,
Speaker 4: there's still big players in the mortgage market for sure.
Speaker 1: So talk to us about what goes into producing a
Speaker 1: mortgage rate. So if I want to buy a house,
Speaker 1: and I go to a bank and I ask for
Speaker 1: a mortgage, what are the individual factors that go into
Speaker 1: the number that eventually gets quoted back to me?
Speaker 4: Okay, Yeah, So let's assume for sake of argument, this
Speaker 4: is alone that conforms to Fanny and Freddy's standards, because
Speaker 4: that's the ones we're talking about here. Okay, So assuming that, right,
Speaker 4: your bank has to pay Fanny or Freddy a guarantee fee. Okay,
Speaker 4: So that is gfee, the GFI exactly, and that is
Speaker 4: based on your credit situation, so how much you're putting down,
Speaker 4: what your credit score is, that sort of thing. But
Speaker 4: it's all algorithmics, so they're just typing into a computer
Speaker 4: or fanning Freddy's kicking back, here's the rate. Right. Then
Speaker 4: they're also going to think to themselves, okay, well where
Speaker 4: can I sell this mortgage?
Speaker 2: Right?
Speaker 4: What price am I going to get when I sell
Speaker 4: it in the open market? And that depends mostly on
Speaker 4: just what the general price is for the going rate
Speaker 4: for mortgages, but it might depend a little on your situation.
Speaker 4: So we can get into it how certain kinds of
Speaker 4: mortgages command a bit more of a premium in the
Speaker 4: market than others, and that will go in to the
Speaker 4: rate you're gonna get quoted. And so every night the
Speaker 4: bank's mortgage desk is sort of plugging in, hey for more.
Speaker 4: It's like this, we'll offer this rate from words like that,
Speaker 4: we're off this right, and all these factors are going
Speaker 4: into that. So when your loan officers typing this into
Speaker 4: his computer, that's what's spitting out right.
Speaker 3: Actually, let's back up what makes a mortgage conforming versus
Speaker 3: non conforming.
Speaker 4: The biggest thing is the price. Okay, So the price
Speaker 4: relative to used to be a hard number, but now
Speaker 4: Fanny and Freddy do it relative to your sort of
Speaker 4: MSA or your area.
Speaker 3: So wait, above a certain price, can you go into
Speaker 3: that a little further above a certain price? Fanny and
Speaker 3: Freddy just want.
Speaker 4: Yeah, they're just not backing it, and that has to
Speaker 4: do with their mandate from Congress to be about affordable housing.
Speaker 3: God, yeah, got.
Speaker 1: So you outlined what happens when we go to a
Speaker 1: bank and we get a mortgage. What happens in the
Speaker 1: sales process, So that mortgage eventually gets sold on the
Speaker 1: open market. As you said, how does it get sold?
Speaker 4: Right? So, the bank's going to pool together a number
Speaker 4: of mortgages, and by a number, I mean kind of
Speaker 4: any number. You can have a dozen mortgages in a pool.
Speaker 4: You could have one hundred thousand mortgages in a pool.
Speaker 4: And so they'll but they'll pull them together. What they're
Speaker 4: going to try to do is just get best execution,
Speaker 4: like any other trade that you do in any other market. Right,
Speaker 4: And the way they're going to get best execution is
Speaker 4: by grouping the loans together that command a premium. All right,
Speaker 4: So let me give it for instance, it is apropos
Speaker 4: to Joe's refinancing situation. If you're in New York, if
Speaker 4: you have a pool that's all New York loans, that's
Speaker 4: going to get a premium. And the reason is because
Speaker 4: in New York, this transfer tax makes refinancing more expensive
Speaker 4: for a New Yorker. So New York loans refinanced slower
Speaker 4: than all the other loans. And so what we call
Speaker 4: that in the mortgage business call protection. So if for
Speaker 4: every basis point decline in rates, a New York loan
Speaker 4: is gonna pay a little slower, and that tends to
Speaker 4: be advantageous to the investors. So they're gonna take all
Speaker 4: If they've got thirty New York loans and thirty Oklahoma loans,
Speaker 4: they're not gonna pull them together because that would waste
Speaker 4: their money. They're gonna put all the New York loans
Speaker 4: in one loan and get a premium for those, and
Speaker 4: just sell all of the Oklahoma ones at the at
Speaker 4: the kind of generic.
Speaker 3: Right, that's interesting. So if I'm a buyer, I pay
Speaker 3: a little bit more for New York loans because of
Speaker 3: that less sensitivity the REFI you know, I was thinking,
Speaker 3: so again, I'm not trying to get too into my
Speaker 3: personal finances, but I remember around twenty twenty three and
Speaker 3: mortgage rates hit eight percent, and a lot of things
Speaker 3: that people were saying, including like mortgage brokers you call
Speaker 3: you on the phone or whatever right after you enter
Speaker 3: into some website like oh, don't worry about the high rates.
Speaker 3: You just refinanced in a few years. And I you know,
Speaker 3: I'm very emh brained. So I'm thinking like, well, if
Speaker 3: everyone is already planning on refinancing in a few years,
Speaker 3: then there probably is going to be the great refinance opportunity,
Speaker 3: because not everyone can just take that free lunch, you know,
Speaker 3: when it is eight percent and everyone's like, yeah, I'm
Speaker 3: just going to refinance though in a few years, so
Speaker 3: it'll be fine. Does that sort of like factor into
Speaker 3: the mouth of how much premium the buyer demand?
Speaker 4: Yeah? I think it really did. And let me give
Speaker 4: a very specific example. So right now, the spread between
Speaker 4: the tenure Treasury and the mortgage rate is relatively large,
Speaker 4: and I'm talking about the investor rate and I'm talking
Speaker 4: about the actual borrow rate you get at the bank,
Speaker 4: right and so there's a lot of discussion as to
Speaker 4: why is that right, And it's been pretty sticky. It's
Speaker 4: it's stayed unusually wide for a couple of years now,
Speaker 4: and I think one of the reasons is what I
Speaker 4: would call severe negative convexity. So negative convexity is this
Speaker 4: idea I said earlier, where boy, if interest rates rise,
Speaker 4: I don't really get any benefit from buying mortgages, but
Speaker 4: if instrates fall, I don't get any upside either, right,
Speaker 4: So that's this idea of negative vexity. Well, if you
Speaker 4: have everybody laser focused on REFI opportunity, right, maybe the
Speaker 4: kinds of people who never check on interest rates, right,
Speaker 4: but all of a sudden they're like, I'm checking every day.
Speaker 4: I want to know the moment if they're laser focused
Speaker 4: on that and the moment they have any opportunity, they're
Speaker 4: going to be right on it. Right. Well, that's a
Speaker 4: different kind of negative condexity. I'm going to take my
Speaker 4: bond that I own is going to refive faster than
Speaker 4: it might otherwise at a time that people on mayor
Speaker 4: may or may not be paying attention. Right. So, as
Speaker 4: an investor, you just mentioned your your efficient markets billed. Yeah,
Speaker 4: as an investor, I'm not unaware of that. Right, I'm thinking, boy,
Speaker 4: these things are going to pay like a bat out
Speaker 4: of hell the moment interest rates drop even a little
Speaker 4: and I need to get paid a little more for that.
Speaker 3: Tracy. By the way, you and listeners right now should
Speaker 3: go to Google Trends and look for a search of
Speaker 3: the word no. Seriously is a great charge. Someone had
Speaker 3: showed to me this a few.
Speaker 1: Weeks discussing line goes up.
Speaker 3: Look at the word Do a Google Trends search for
Speaker 3: the word refinancing, and you will see a big spike
Speaker 3: on September eighteenth because it was you know, not everyone's
Speaker 3: always paying attention to rates, But there's like one day
Speaker 3: this year where the Fed actually made some pretty significant
Speaker 3: news that sort of broke through the bubble, and you
Speaker 3: could see how suddenly there were a bunch of people
Speaker 3: paying attention to rates. Ironically, they didn't get any real
Speaker 3: benefits automatically, but you could see how people don't pay attention.
Speaker 3: And then there's a day when someday they were.
Speaker 1: The futility of doing Google research. Everyone wants to refile
Speaker 1: on that specific date and they can't get a lower
Speaker 1: rate anyway. Tom I wanted to ask, what is the
Speaker 1: ideal environment to be buying mortgages in because I think
Speaker 1: back to the years after two thousand and eight when
Speaker 1: interest rates were really low, and I remember big investors
Speaker 1: in mbs. They always complained, you know, they didn't want
Speaker 1: to get prepaid because then they would have all this
Speaker 1: extra money that they would have to reinvest at lower rates.
Speaker 1: But now we're in the higher rate environment and they're
Speaker 1: also complaining, So like, what is the ideal here?
Speaker 4: Yeah, So one way to think about mortgage investing is
Speaker 4: and I'm going to play on another odd lots theme here, please,
Speaker 4: It's a little like doing a covered call strategy in
Speaker 4: a stock all right. So what I've kind of done
Speaker 4: is I bought a bond and I've also sold an
Speaker 4: option to the borrower, and that option is to call
Speaker 4: my bond away, right. And it's just like if I
Speaker 4: buy Microsoft and I sell an option for someone to
Speaker 4: buy Microsoft from me. It's exactly the same trade. And
Speaker 4: if you think about that trade, right, what you want
Speaker 4: is for Microsoft to do nothing, because if it goes down,
Speaker 4: I've lost money. If it goes up, I get called away, right,
Speaker 4: But if it does nothing, I just collect that premium
Speaker 4: and I still have my stock. Right, So what you
Speaker 4: want is for interest rates to stay very steady. Okay,
Speaker 4: and nobody really gets to refinance. But I don't suffer
Speaker 4: the downside that I suffer if interest rates rise, and
Speaker 4: so mortgage is it's a tough It can be a
Speaker 4: tough total return bond. So like if you think about
Speaker 4: someone trying to trade it and play interest rates move around,
Speaker 4: that's not that great. What it is is a good
Speaker 4: income bond. So I buy it to collect this income.
Speaker 4: If interust rates can stay steady, it can be a
Speaker 4: great bond to own.
Speaker 1: And this is why people call them pass throughs, right.
Speaker 4: Well, yeah, passive. The other thing people will say is
Speaker 4: it can be a good defensive bond. So if you
Speaker 4: think that corporate bonds are going to suffer because there's
Speaker 4: gonna be a recession, a lot of times people will
Speaker 4: rotate into mortgage bonds because they're still yield there and
Speaker 4: they're not as sensitive to that part of the cycle.
Speaker 4: Usually when that happens, interest rates drop a lot and
Speaker 4: you're not getting that upside and so I don't know,
Speaker 4: there's a tough space. It's a tough space.
Speaker 3: Do Americans under refinance? I mean there must be some
Speaker 3: population that doesn't pay attention. So I'm looking at you know,
Speaker 3: mortgage rates in twenty ten, at one point December thirty first,
Speaker 3: twenty ten, they're at four point nine to nine percent.
Speaker 3: They had gotten as low in twenty sixteen at three
Speaker 3: point three percent. You know, I imagine in your covered
Speaker 3: call strategy, anyone engaging in these things are very sophisticated
Speaker 3: and you call it right away. Is there an advance
Speaker 3: for mortgage buyers sort of taking advantage of the fact
Speaker 3: that the counterparty to this trade is not watching rates
Speaker 3: all day?
Speaker 4: No, for sure, that is true. So this concept in
Speaker 4: mortgage trading called burnout, okay, and this is the idea
Speaker 4: that at a certain point everyone who's going to refinance
Speaker 4: has refinanced. Yeah, So if we rewind to twenty twenty,
Speaker 4: twenty twenty one, r ine traates were really low, you'd
Speaker 4: still see five percent mortgages outstanding, and you'd be like, well,
Speaker 4: why what are they doing?
Speaker 3: Get on life right and not paying attention to an
Speaker 3: interest rate right now?
Speaker 4: Sometimes they're just not paying attention. Sometimes they may maybe
Speaker 4: something's happened with their credit and they can't get a
Speaker 4: lower rate at this point, which you can get a
Speaker 4: ton of detail on what the mortgage conditions were when
Speaker 4: the bar were initiated the mortgage, but you don't know
Speaker 4: that much about where they are in their life now, right.
Speaker 4: You just really only know what happened when they applied.
Speaker 4: So you can get that. You can also get people
Speaker 4: who are thinking about just paying off the loan and
Speaker 4: they don't want to restart the clock. So if I've
Speaker 4: been in this house for ten years and you're like,
Speaker 4: I know, I get a lower rate, but then I
Speaker 4: got to reset the clock, maybe a fifteen year more
Speaker 4: you do a fifteen year old origion, but maybe that
Speaker 4: monthly P and I is too much for me.
Speaker 3: So there's something nice about just paying off a mortgage.
Speaker 4: And accutely, And that's a personal preference. Some people that's
Speaker 4: what they want to do. Some people think that's a
Speaker 4: bad financial idea, but I think it's up to you.
Speaker 4: But anyway, that certainly happens, right, And so it's not
Speaker 4: all just not paying attention, but it's not there's an
Speaker 4: element of that for sure.
Speaker 1: I want to go back to the spread between mortgage
Speaker 1: rates and treasuries, which, as you pointed out, has been
Speaker 1: pretty wide in recent years. And I know You mentioned
Speaker 1: the negative convexity point, but do you see anything like
Speaker 1: structural that's happened in the market that has led to
Speaker 1: that bigger spread.
Speaker 4: Yeah, Well, the flat curve they mentioned is part of it, right,
Speaker 4: because there's a lot of players. Normally the arbitrage would
Speaker 4: be hey, leveraged owners, which could be banks, but could
Speaker 4: also be mortgage rates, other hedge funds. Anybody could come
Speaker 4: in by the mortgage rate at this relatively high maybe
Speaker 4: hedge it with treasuries and borrow in the repo market,
Speaker 4: do that whole trade up. But it should work, right,
Speaker 4: But if the curve's pretty flat, then you need more
Speaker 4: heeld to make it work, and all of a sudden
Speaker 4: there's no arm there, right, So I think that's part
Speaker 4: of it. I also think the fact that people see
Speaker 4: the housing market as a little frozen right as part
Speaker 4: of it, right, because there's so many people in one
Speaker 4: part in very low rates they're kind of stuck there,
Speaker 4: and there's people in very high rates they're kind of
Speaker 4: like unable to refinance right now. So I think that's
Speaker 4: part of it. I think that earlier I'm going to
Speaker 4: go back to my call writing analogy. There's a vix
Speaker 4: to the interest rate world. It's called the move index.
Speaker 4: You can look at on by your terminal and you
Speaker 4: can see that's relatively high. And that plays into how
Speaker 4: people think about mortgages because if the volatility of interest
Speaker 4: rates is relatively high, then the cost of the option
Speaker 4: is relatively high, the cost of the options is relatively
Speaker 4: then the mortgage rates can be relatively eye right. So
Speaker 4: I think that all plays into it. In my opinion,
Speaker 4: the negative convexity bit is the most important one. The
Speaker 4: vall bit could improve as we get a little more
Speaker 4: clarity on the FED if we stop whipping from oh,
Speaker 4: if it's going to do eight cuts, No, they're going
Speaker 4: to do two. If we could get into like, okay,
Speaker 4: we kind of know the path here, then I think
Speaker 4: that voll bit could come down. But and that might
Speaker 4: be worth twenty twenty five basis points on the mortgage rate,
Speaker 4: But I don't think we're in all the way to
Speaker 4: more historic norms of like one hundred and fifty basis
Speaker 4: points spread from treasuries to mortgages until we get a
Speaker 4: little bit less negative convexity.
Speaker 1: Thank you so much, by the way for tying the
Speaker 1: move index to mortgage rates, because I'm actually writing about
Speaker 1: it in our newsletter today, the Odd Thoughts Newsletter now.
Speaker 3: Daily Odd Launch newsletter used to be weekly. Go there
Speaker 3: and sign up for it.
Speaker 1: Yeah, that was my very eloquent plug for the newsletter. Okay, Tom,
Speaker 1: at what point does the spread like get wide enough
Speaker 1: that it does entice buyers into the market. Presumably they're
Speaker 1: it must be like a level at which it does
Speaker 1: become interesting. Or is it the case that it's just
Speaker 1: never going to compete with something like, I don't know,
Speaker 1: a commercial mortgage or a high yield bond or something
Speaker 1: like that.
Speaker 4: Well, you know, I would say at the beginning part
Speaker 4: of this year, mortgages became a really popular trade in
Speaker 4: the money management business. So I'm just talking about regular
Speaker 4: old bond funds. I heard a lot of people talking
Speaker 4: up this trade, and the reasons were what you described.
Speaker 4: They're like, look, the spreads are really wide. At that time,
Speaker 4: we were saying, you know, the Fed's done hiking, maybe
Speaker 4: a cut's coming. Maybe that'll cause in straight vault to decline,
Speaker 4: So there could be a spread compression opportunity here. I
Speaker 4: think there was also an argument that there could be
Speaker 4: some risk of corporate spreads widening corporate spreads were really tight,
Speaker 4: and so relative to corporate spreads, mortgages were pretty attractive.
Speaker 4: And mortgages have performed fine if it's not been a disaster,
Speaker 4: but they've underperformed corporate bonds. And I think the problem
Speaker 4: has been that this negative convexity issue is interest rates
Speaker 4: have dropped, mortgages have just underperformed, and corporate spreads have
Speaker 4: keeped tightening. And so money managers have been underweight corporate
Speaker 4: bonds for a decade. If you go back and just
Speaker 4: look at a soil chart of where general bond funds are,
Speaker 4: they've been underweight mortgages forever. So there is an opportunity
Speaker 4: for them to come in. But like I think that
Speaker 4: started happening and they all got disappointed, and so we'll
Speaker 4: see if that continues.
Speaker 3: You know, earlier when you said you're going to touch
Speaker 3: on a odd blog see theme, you said the move index.
Speaker 3: But I thought you were going to go to the
Speaker 3: supply chain aspect, because there is this supply chain right
Speaker 3: of mortgages. And I remember that in like summer or
Speaker 3: spring of twenty twenty, when interest rates were sent to zero,
Speaker 3: that one of the stories that was out there was
Speaker 3: that there was so much demand for refin activity that
Speaker 3: actually the humans who had to do it, oh where
Speaker 3: they were human capital.
Speaker 1: Married under paperwork because there's.
Speaker 3: A lot of paperwork, which also speaking of why people
Speaker 3: might not refly like paperwork, it's a really annoying especially
Speaker 3: after the Great Financial Crisis, just hundreds of documents. That's
Speaker 3: not fun. Can you talk a little bit about the
Speaker 3: sort of like the infrastructure of mortgage capacity and how
Speaker 3: that's evolved over time?
Speaker 4: Sure, sure, I do. I feel like we're hitting odd last,
Speaker 4: that's very real. And what the banks will do is
Speaker 4: they'll assess, well, boy, how many mortgages can we process
Speaker 4: in a day? Right, and that will help them set
Speaker 4: the rate right, because there's no sense in being overly
Speaker 4: competitive with your rate if I can't even process right. So, yeah,
Speaker 4: so that is that absolutely can be an issue now
Speaker 4: right now. The opposite is there there's just not enough
Speaker 4: business to be done, right. You just mentioned applications being
Speaker 4: so low, and so that probably has resolved in a
Speaker 4: little under hiring in the space. Right. Maybe there'st been
Speaker 4: a ton of lay offs, but there certainly has not
Speaker 4: been a ton of hiring, right, And so maybe maybe
Speaker 4: that's just through attrition head councer down in that space.
Speaker 4: And so if there is a surprise and in twelve
Speaker 4: months mortgage rates are four or some such, we will
Speaker 4: absolutely be talking about that. Again.
Speaker 3: Absolutely interesting.
Speaker 1: So I'm going to ask the question that I'm sure
Speaker 1: is on everyone's mind per that Google trends chart, but
Speaker 1: when do mortgages come down?
Speaker 3: Yeah?
Speaker 4: Or what will it take it?
Speaker 1: Yeah?
Speaker 4: So we should. Let's let's talk about why they've risen
Speaker 4: since that FED meeting, and then that I think that'll
Speaker 4: inform where they're headed. Right, So, look, the tenure treasury
Speaker 4: is not a function of where the FED is today.
Speaker 4: It's a function of where people anticipate the FED being
Speaker 4: in the next year two, three, right, and beyond three
Speaker 4: it's sort of fuzzy, but like you know, year two,
Speaker 4: we sort of have a sense, right, we can make
Speaker 4: a guess. And so going into that September meeting, people
Speaker 4: started thinking themselves, Boy, then my cut fifty basis points
Speaker 4: in September, fifty basis points in November, maybe even fifty
Speaker 4: more basis points in December. Right, you pull up your
Speaker 4: WRP chart on the terminal. You can see this, right
Speaker 4: if you go back to then. But since then, what happened.
Speaker 4: We got a big jobs report the beginning of October.
Speaker 4: That was the September report, but came out October, and
Speaker 4: that was kind of a game changer, because not only
Speaker 4: did we get a solid number for September, but it
Speaker 4: was huge upward revisions kind of erased what looked like
Speaker 4: a downward trend in hiring. Right. Well, now all of
Speaker 4: a sudden, we're like, boy, the FED might be a
Speaker 4: lot closer to that neutral rate than we think. Right,
Speaker 4: They're probably gonna still cut in November, but maybe they'll
Speaker 4: cut in December. Maybe they won't, but if they do,
Speaker 4: it's certainly not gonna be fifty basis points unless something changes.
Speaker 4: And so that change in expectations has caused a tenure
Speaker 4: to rise, so commensurately the mortgage rate has risen, right,
Speaker 4: And so from that store you can say, all right,
Speaker 4: well it comes pretty easy to see what's going to
Speaker 4: cause mortgage rates to drop. The tenure needs to drop, right,
Speaker 4: And what's going to cause the tenure to drop, Well,
Speaker 4: we're gonna need more FED cuts priced in. What's going
Speaker 4: to cause more FED cuts get priced in? We need
Speaker 4: the economy to get weaker.
Speaker 3: By the way, I'm just gonna I'm not gonna pose
Speaker 3: this as a question. But another thing that has happened
Speaker 3: since September eighteenth is that the odds of Donald Trump
Speaker 3: winning have gone up significantly if you look at the
Speaker 3: betting market, and there is a widespread view among economists
Speaker 3: that thanks to tariffs tax cuts, that could also mean
Speaker 3: a reflationary impulse in the economy starting maybe early next year.
Speaker 3: So I'm just throwing out there. You know, you mentioned
Speaker 3: the jobs report, but policy may get more reflationary after January.
Speaker 4: That I do think that's the consensus view that it's
Speaker 4: starting out as it means higher interest rates. Like, we'll
Speaker 4: just see if that happens. But I think the key
Speaker 4: here is that it's about an anticipation period because even
Speaker 4: what you're saying, Joe about potential, you know, change in
Speaker 4: physical policy functions, what you're saying, right, that's a big change.
Speaker 4: That's an anticipation as well, right, So it's all about
Speaker 4: what's being anticipated now, what's happening in real time.
Speaker 3: By the way, Tracy, obviously Tom mentioned people looking forward,
Speaker 3: and you know, people, it's funny people are talking about
Speaker 3: long and variable legs with monetary policy. But I increasingly
Speaker 3: think it should be long and variable leads because rates
Speaker 3: have been falling for over a year, well before the
Speaker 3: FED formally Yeah about cuts. So there's a sense in
Speaker 3: which he's one of my favorite phrases, you know, is
Speaker 3: priced in.
Speaker 1: Yeah, markets be four at looking, that's for sure.
Speaker 4: Tom.
Speaker 1: You know, we would be remiss if we didn't ask
Speaker 1: a veteran MBS trader and analyst what two thousand and
Speaker 1: eight was, like, give us some war stories.
Speaker 4: I mean, I lost a lot of weight, super stressed.
Speaker 3: No, that's great.
Speaker 4: Yeah, yeah, it was the worst reason I've ever had
Speaker 4: was What was wild about that time was no one
Speaker 4: really knew how deep it could get, right, Like, there
Speaker 4: was a lot of assumptions people made, well, I mean,
Speaker 4: if this happens, then like, but we also were living it, right.
Speaker 4: So when Fanny ma and Freddy Mack were taken over
Speaker 4: in the beginning part of September, this was a week
Speaker 4: or there's about two weeks I believe before Lehman failed,
Speaker 4: which is almost equally as big a deal, but kind
Speaker 4: of forgotten to history was Fanny made Freddy Mack were
Speaker 4: taken over because they were functionally insolvent and they became
Speaker 4: under pressure through early on nine to sell down their
Speaker 4: mortgage portfolio. Okay, so at that time, Tracy, you asked
Speaker 4: who buys mortgages? Well, at that time I said, well,
Speaker 4: Fanny made Freddimac. They're they're number one. So they were
Speaker 4: not only guarantee mortgages, but they were a big buyer. Okay,
Speaker 4: And is that left the market? Not only was there
Speaker 4: just a ton of fear, was lack of capital available
Speaker 4: in general, which had this big player who was kind
Speaker 4: of gone, right, And so mortgage spreads, the spread we
Speaker 4: were talking about between treasuries and with that went through
Speaker 4: the roof, right, So and then we had to reassess like, well,
Speaker 4: what does this mean if this big player's footprint is gone.
Speaker 4: And then of course as they became more of a
Speaker 4: permanent war to the state, how they went about guaranteeing mortgages,
Speaker 4: what the GFE, how the gfe's worked, all that stuff
Speaker 4: got reformed, and so it's been a massive change in
Speaker 4: the space for sure. You know.
Speaker 3: Just one last question for me, and again it's sort
Speaker 3: of technical, all this paperwork, why can't we just have
Speaker 3: like one is it just impossible to imagine that one
Speaker 3: click refise whatever exists because of all the credit check
Speaker 3: you know, I'm just like used to everything else finance,
Speaker 3: like one click move of your account from here to hear,
Speaker 3: one click do to this, And I was like, why
Speaker 3: does someone offer one click mortgage REFI is just is
Speaker 3: it just always going to be too much human capital
Speaker 3: intensive for something like that because you've been a great product.
Speaker 4: Yeah, my bet is that regulation makes that hard. Right, So, like,
Speaker 4: if you're gonna sell it to fan, we're gonna get
Speaker 4: the guarantee. You actually, you actually can get guarantee without
Speaker 4: selling the mortgage. But let's say you're gonna get the guarantee,
Speaker 4: then you're gonna have to go through Fanny and Freddy's hoops,
Speaker 4: which you won't be shocked to know that their computer
Speaker 4: systems aren't aren't the greatest. So you always have that right.
Speaker 4: And then but the bank itself is going to have
Speaker 4: to follow certain regulations even it's going to keep the
Speaker 4: loan on book, right, And so I suspect that's that
Speaker 4: element makes that difficult. That would be my bet.
Speaker 1: I feel like that's usually the answer to questions about like, well,
Speaker 1: why don't we just use technology to make it easier.
Speaker 1: It's usually regulation.
Speaker 3: I wonder if there's ever been any like why combinator
Speaker 3: startups like we're going to do one click reefise, et cetera,
Speaker 3: and then they run into it's like, oh, actually, there's
Speaker 3: just a bunch of reasons why this product doesn't exist anyway.
Speaker 1: Yeah, if you've run a failed one click mortgage startup,
Speaker 1: let us know and we'll have you on the podcast.
Speaker 1: All right, Tom, that was absolutely amazing. You were truly
Speaker 1: the perfect guest to talk about high mortgage rates. So
Speaker 1: thank you so much for coming on off on.
Speaker 4: Thanks for having me, Joe.
Speaker 1: That was so good to have Tom on talking about
Speaker 1: all of this, And I do feel like I understand
Speaker 1: it more. It is funny. I mean, I do think
Speaker 1: when you think of easing in monetary policy, like one
Speaker 1: of the big transmission mechanisms is still supposed to be
Speaker 1: mortgage rates. Right. But I think if we've learned one
Speaker 1: thing from our current experience, it's that that doesn't always
Speaker 1: necessarily pass through. The pass throughs don't pass through.
Speaker 3: Yeah, I would say two things. It's like the pass
Speaker 3: throughs don't happen in a very linear, predictable way. There
Speaker 3: is nothing that happened on September eighteenth that made everybody's cost.
Speaker 3: There are some instruments, you know, short term instruments that
Speaker 3: are directly tied to the FED funds rate, but nothing
Speaker 3: mechanical happened on September eighteenth that just like made cost
Speaker 3: borrowing and everyone new September eighteenth or that a FED
Speaker 3: cut was eventually coming as inflation started to roll over
Speaker 3: after its peak, and therefore the FED cutting did create
Speaker 3: lower rates. It just happened in anticipations cut rather than afterwards.
Speaker 3: But it is ironic then that you get that big
Speaker 3: surge in people looking for refinance after it was fully
Speaker 3: priced in.
Speaker 1: I do like your leading lag idea.
Speaker 3: Thank you.
Speaker 1: You should write about that in the newsletter.
Speaker 3: That's a good idea. Maybe I'll write about it Monday,
Speaker 3: our new daily Odd Lots newsletter. Maybe I'll write about
Speaker 3: it Monday when this episode comes out.
Speaker 1: Yeah, Okay, I think we've said new daily newsletter enough
Speaker 1: on this episode. Shall we leave it there?
Speaker 3: Let's leave it there.
Speaker 1: This has been another edition of the All Thoughts Podcast.
Speaker 1: I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 3: And I'm Jill Wisenthal. You can follow me at The
Speaker 3: Stalwart follow Tom Graff. He's at tdgraph. Follow our producers
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