A Broken Market Is Causing Mortgage Rates to Surge

we could get even more detailed. Well, absolutely, because we talked about what is the impact of higher rights on housing, but we didn't really talk about why have rates gone so much higher? And I know, like this is all I know about housing finance. I know the government like backstops a lot of or implicitly or explicitly actually I'm not even sure anymore, but backstops all a lot of

it does it does even more. It's so like you start with like the sort of risk free rate on like treasuries because it's government, and then you add some spread and that's like the average more and then I don't know anything beyond that. Well, that's a fair question that where does that spread come from? Why do people make additional money or why do they demand an additional premium for investing that's in something that has a guarantee

from the US government. Yeah, exactly right. This is the part I don't understand, Like, if the if the asset is backed by the US government, why don't we get mortgages the same rate as treasuries? But it's not because right now, a third year treasury somewhere on four percent and a third year mortgage is around seven percent. And that's spread various quite a bit from time to time. So even as recently is last spring, the gap between a mortgage and a treasury had gotten down to less

than one percent. Now it's around three percent. Where did that spread come from? And why does it change over time? Or two things? I just don't know the answers right well. Also, that three percent spread is like at the highest that it's been I think of all times. So like something is happening in the mark it right now that is different to the way it used to work, and I think we need to dig into that. You know, we spoke a little bit with Jim about it, but we

really need an expert. And I got to say I was sort of bated by there was a tweet recently It started with I'm not about to go on a podcast to explain why, but this year has likely broken the market for mortgage backed security. That was a dare time. It's like if he's like you did now, just like I'm not going to go on a podcast, It's like, all right, let's try us, let's see, let's see if you can resist. Okay, well, here is the podcast to

explain why the MBS market seems to be broken. We are going to be speaking with really the perfect guest. We have Guillermo rodit Domingo's He is the managing director at New River Investments, and he is going to explain all of this to us in detail. One of our super fans, I think really, I think so. He's one of the first to tweet them often so and we've known him a long time. So very excited about this conversation. So maybe it wasn't a dare, or maybe it was.

You know, please pick me for the podcast, Guermo. We are delighted to have you on. Really looking forward to the conversation. I am very very very happy to be honest. A bucket list item for me, and you know I do stay up until very late at night. So I can listen to you know, odd Lots and tweet out my notes before anybody else wakes up. I love that. That makes me happy. Okay, So why don't we start out with Here's a very simple premise, is the current

moment in the mortgage market. And you know, when I say the mortgage market, I'm kind of talking about mortgage back securities a k A m b S. A lot of people will think back to you know, pre two thousand eight times and think of them in that context. But is this particular moment in the mortgage market different or remarkable in some way? Like, can you give us

some historical context around what we're seeing right now? Yes, So this moment is special because it's not happening because people are afraid people are not going to pay their mortgages. Is them because people are afraid house pics it's going

to go down. It's a common nation of the fact that mortgage backed securities went from being effectively short lived assets because we went through a pretty epic refinancing boom in two all of a sudden, rates going up, very very very quickly, faster than anybody expected, pre payments going effectively to zero, and a huge train on neutral funds from tax payments that we're do for games from counter year. That's you know, give or take one and a quarter

trillion dollars. That's probably the highest compared to GDP that we've ever had. This kind of conspired to leave holders of mbs holding securities that have a much longer expected life than than they ex than they originally expected when they purchased them, and you know, the discount rate on that longer life going up, which has been pretty disastrous to the prices of this product. This gets to an

important nuance or an important thing. A person buys a house and it takes out a thirty year fixed mortgage. Let's start really simple. They get a thirty year fixed mortgage. Someone owns that asset, but their expectation is not that they're going to hold that for thirty years. They're not thinking like, Okay, I'm gonna wait thirty years. What is

the typical length via which that asset exists? How frequently in normal times would it either get refinanced by the homeowner or sold because the homeowner sells the house and the loan gets paid back automatically. On a basic on scenario, you would assume that you have a thirty year mortgage transit weighted average life of the castles, because it's an advertising a loan of about you know, fifteen years, and

we have some expectation of turnover. You know, people move, you know, people sell, sell their houses, or prepay their loans for many different reasons, all sorts of life events, and you know that shortens the effective life to you know, about half of that about seven years. And usually we're assuming anywhere between six and eight percent of loans on an annual basis transition, not because they are refinanced to their being a rave incentive, but from any other number

of reasons. During one we saw about thirty six percent of loan balances being extinguished each year. That's a lot, you know, Usually, you know we're expecting about half of that sixteen. You'll recall in the first three course of the year we had pretty low rates and we got up to twenty and that was that was pretty high. And you know t n which was a more normal year,

we were at out seventeen. So you know, this fueled a lot of extinguished singing over those balances, and you know, you you bought what you thought was a seven year asset, and you know, it turned out that it was, you know, a five year asset, and then happens and all of a sudden, you know, you're holding a ten year asset, right, So can we dig into this just a little bit more because I seem to remember during the era of low interest rates, so you know, after two thousand and eight,

when rates were just grinding lower and lower and lower, the big investors in MBS, the big buyers, and we should probably talk about who those actually are. At some point, they didn't want MBS to be prepaid because it basically meant that they would get like a bunch of money that they then had to invest at even lower interest rates.

Now we're in an environment of higher rates, and it feels like MBS is not desirable because suddenly it leaves you with an asset that has much longer duration than you expected and much more exposure to interest rate volatility. Is that right? Yeah, that's correct. I think one way to look at it is a mortgage backed security is

essentially similar to a covered call in equity terms. That means that you know you have all of the downside and you know very very little of the upside and you trade that in for a little bit of extra coupon. And you know, when rates were going down, everybody was upset about it because you know, treasury bonds were going up and frist people are making money there. If you have the NBS, you know you've got your money back, and then you want to buy new bonds. You know

you bought them at a lower yield. And right now what we're seeing is all of a sudden, bond prices are are going down, the yields are going up, and you know you're not getting any castles, so you don't get to reinvest the money. This is sort of a key thing, and I just want to like make it clear.

You know, everybody knows that a homeowner can always like refinance their home, and people talk about like homeowners a third year fixed has like a quote like free option to refinance their home if rates go down after them. But essentially that free option for the homeowner is a theoretical source of risk for the holder of the NBS.

So there's two ways for the MBS holder to lose. It. Sounds like one is, Okay, rates go up a lot and then you're not getting much payment done those bonds or ready to go down and then you have to like, you know, eat that repayment. Yeah, and I mean I would say that it's not a pre option. It's an expensive option. Not always, but right now it is. We're talking about why our mortgages at you know, seven plus

when you know treasuries are at four. You know, just a year ago, treasuries were two and fifty basis points lower, but mortgages were basis points lower. Maybe this is a good moment to sort of step back and talk about who the big buyers of mortgage backed securities actually are. And one thing I would be curious to hear is have they changed from pre two th eight to now? Because of course, I mean the big change has been

the Federal Reserve when it started quantitative easing. You know, it bought a whole bunch of different types of bonds, but one of those was NBA. Now that they're in quantitative tightening mode, they've sort of stepped back from the market. So could you maybe talk a little bit about the ecosystem of who actually purchases these securities and the kind of considerations that they're thinking about as they decide whether

or not to buy more or less MBS. The answer that nobody wants to tell you is that right now there's no natural buyers right you know, and that's that's the problem. You see these spreads go really wide. The problem is that who is the buyer right now? Right now, there is no natural buyers. Postal thousand and eight, you had you know, banks that had expanding deposits and you know, there was not to no loan growth, and so banks kind of building that gap with MS. Bonds funds had

you know, pretty sizable inflows. And when you think about bond funds, you know you're thinking about like people goes total return fund or you know double lens total return fund. These are these are funds that engage in you know, marginal risk ging in a liquid securities in order to boost the yield of their fund. And you know, as long as you keep that a liquid portion to a small percentage of the fundacets, you know, you can enhance

the yield for for the whole fund. Ever since the start of the year, you know, bond funds have been seeing weekly outflows, so there are certainly not buyers there. You know, the Federal Reserve is not a buyer. Banks have demand for loans and managers at banks. You know, I thought that they were ready for the risk that extension of MBS would entail, and it terms out that you know, maybe they don't like it so much, so

they're not buyers of the product. We used to have a pretty healthy demand for some of the cash flows, particularly the more longer dated cash flows. There you would get into you know, transition, but you'd have some demand for that stuff from buyers in Asia, and they're in

over to be seen. And because of this prepayment risk, it's a very poorfeit for people that are in the business of matching assets and liabilities because you know, if you're in the business and matching assets and liabilities, you don't want your asset to get called because the liability is not getting called. So you know, it's a nonstarter for them, very very few people who want to start.

Can we just go back on prepayment risk specifically, And you made a good point that this option that homeowners

have to refinance, it's not a free option. They pay for it and the spread and that's spread is wide, so just you know, seven percent mortgages four percent treasuries, you're actually paying a significant amount to borrow that money is part of what investors are concerned about, or is part of why that option is so expensive right now, simply because there is concerned that like, Okay, there's the spike rates due to the fight inflation, that's kind of temporary,

and that rates might you know, reset lower significantly in a couple of years, and that we get this huge wave of like everyone who can refinances then. So it's like if you're you know, if I'm buying a home right now, I'm probably thinking, well, I really get I really hope this's like inflation fight ends in a couple of years and that I can like refinance or something. That's exactly right. Nobody wants to take their money at

this point. You know, if you've had cash up until now, you know you've done very well versus the losses that you know, everything else has taken. So if you're going to put money to work now, why are you going to put it into an asset that you know that may have capped upside? For most people, it's it either doesn't make sense or it's just not something that they're willing to consider. You know, if rates go down and you buy treasuries, you're gonna make up boatload of money.

If rates go down and you buy MBS, you might not make any money. Can you talk about like whether or not there are forced buyers or buyers who have to buy MBS. And I'm thinking specifically of, you know, situations where you might have a bond fund that's benchmarked to a benchmark index, something like the Bloomberg Barkley's AGG

or something like that. And I seem to recall there was some discussion again in the mid two thousands that it was unfair that the Barkley's index still included a bunch of MBS when there wasn't actually that much MBS in the market because the FED was buying it, and MBS was a source of duration for a lot of the funds, and if they couldn't, you know, buy MBS, and they couldn't be as exposed to duration as the benchmark index. And so you had people like Pimco actually

complaining that there wasn't enough MBS in the market. So it's kind of ironic that fast forward, you know, seven years or something, and a lot of these big buyers don't want to touch MBS with a ten foot poll after complaining that, you know, they couldn't get enough of it. Anybody that tracks an index is not gonna be necessarily a forced fire because the funds that track an index don't necessarily replicate it down to every single line item.

That's you know, incredibly difficult to do. In fix sincom, where you know, you're talking about tens of thousands or hundreds of thousands of different bonds, and especially in NBS where you don't have a fungible product, you know, there's you know, thousands of thousands of pools that are packaged in different ways, and dealers will often sell you know, the entirety of an issuance to a single buyer, and so there's no chance for anybody to really replicate It's

it's impossible to replicate an index, and so you know, you have some leeway around that. And sure there's you know, there's flows going into index trackers that are going to replicate that, but there's also a lot of funds leaving, you know, a lot of flows out of different products that are more heavily exposed two mbs and I wouldn't be thinking about four spires. I'm thinking about four sellers. Sorry, Can you expand on that point a little bit more

like what would trigger a for sale of MBS. Let's say you know you have uh total return fund at at a large manager, you know, well known large manager, and you're participating in the MBS market. Is that way you can get some extra spread for your clients and you can get them, you know, a little bit of a higher return. And all of a sudden, starting this year,

you start getting massive outflows. And maybe you keep I don't know, five or ten percent of your assets in super liquid securities and that's going to be bills and and one your treasuries or you know, to year notes,

and all of a sudden, outflows keep coming. You run through your bills, you run through your one year notes, you know, you run through your two year notes, and all of a sudden, you know, you're pre payments, which you know, we're coming in every month, and you were cash flowing a lot from from those pre payment some nbs, all of a sudden they totally stopped. So you you have outflows, you have no cash flow coming in, Well,

you're gonna have to sell something. And you know, unfortunately for for many managers, we've been seeing since about March, you know, kind of a relentless number of We call them be wicks since for bids wanted in competition, it's essentially when you option off your bonds to the highest bidder. And you know, we've seen that a lot of these

options bring few or no participants. We have this period of high inflation, so of course there's a lot of second guessing about all kinds of policies that we're going on in one etcetera, fiscal, monetary, etcetera. And one of the criticisms of like why was the FED still buying you know, mortgage backed securities up until you know, relatively recently in your view, can we quantify the degree to

which that FED buying depressed spreads? Or to put it in another way, like, okay, we have this, you know, this represent spread between mortgages and treasuries. Can we, like I can we decompose, like how much of that can just be explained via the FEDS switching from being a

buyer to a seller of these assets. I can give you my best estimate, and so that would be for when you're talking about calendar year, I would say about to thirty basis points was from you know, QUI continuing maybe later than we needed to, we don't have a

counterfactual of no que to look at. And if we look at before their great financial crisis for that kind of counter factual, well, the market was a lot, there was a lot more private label and bs, the implicit guarantees were maybe a little bit less implicit, and there was less market share dominated by Jinny May, which is

obviously an explicit guarantee. But I would say that if you wanted to compare to you know, the FED not intervening at all, I think fifty basis points is not a bad guess, but you know, versus scenario, I would say about twenty five basis points. That's that's how much the depressive spread. Can you talk a little bit more

about what's going on with the banks? So they're a big buyer of mbs, as you mentioned, and I've seen some discussion, you know, for instance, JP Morgan had a note a couple of weeks ago talking about how leverage and risk capital requirements for the big banks basically makes it much more difficult for them to hold onto these assets, to hold onto mbs, and so they haven't been buying as much of them, and that's one reason why that's spread between benchmark rates i e. Treasuries and mortgage rates

has been going up. Is that a valid analysis or is this another excuse for big banks to complain about various regulatory requirements. I think it's a valid criticism. I think it was just last week or pride of that to them and said that, you know, they don't want any aret of the conforming mortgage space, but they're not participating that at all. Currently. The capital requirements they don't

make it prohibitive for banks to participate. It just means that if they have demand for loans, well that's more attractive to them, and so they're not going to participate in something that is like relatively less attractive. You know, if they can originate a lot of personal loans were not conforming loans or credit to their their corporate borrowers, they're probably going to focus on those activities instead of

you know, buying mbs. The other part of it is that everybody kind of assumed a certain base level of prepayments that in retrospect was not sustainable. I don't want to say sustainable, but you know, everybody kind of assumed that there will be a flour like that even if rates went out pre payments wouldn't decline past a certain point, and they did, and maybe you bought a bond and you thought, well, worst case scenario, rates go up, and

then you know the duration of it. You know, it goes from from three years to five years, and you know, it turns out that now you're looking at six and you know, you thought you would be comfortable with five, but it turns out that you don't feel so comfortable with five, and now you have six on top of it, you know, And so there's just a general lack of

appetite for this. And you see this a lot. I mean, you know managers and banks that are just you know, normal people, and they have the same biases and reactions as all of us. And you know, you get you get burned by something you don't want to do it again,

and they just got burned by the extension risk of them. Yes, in the intro, since you mentioned the difference between conforming and nonconforming loans, and in the intro, I was like, wait, you like Fanny and Freddie still exist because I kind of forgot about them and tratically like give me like a really like me and look like what it is? What I mean, I just roll my eyes. She was she was surprised that her co host could say something

so stupid, like do Fanny and Freddy? But I actually don't know what's going on with them because I just they're like penny stocks now and I don't really know what happened. So could you talk a little bit about like what they do now? Like what is their role? How big is the difference between the conforming versus nonconforming? Like where do things stand with the g c s. Well, they're a huge part of the market. I can't tell you the exact percentage right now. I actually don't have

the number in front of me. Jenny May has been growing their share over the last decade, but you know, Fannie and Freddy are still huge players. And you know their role is that DIVII loans from from originators and then they know they package someone to two MBS and saw them at the market, and they're not in the

business of, you know, speculating on racist spread. You know, they basically just facilitate moving those loans from loan originators to the the private buyers in the in the market, and as part of that, they guarantee the credit of the loans and that's about fifty five basis points effectively. There's you know, there's gonna be some variation there because you know, some borrowers or more credit worthy than other borrowers, and and certain types of loans are penalized. But I've

ruled that. I think that people don't really consider is that you know, they do have certain policies. They act to an excellent sort of policy, right, you know, earlier this year, at the end of January, I believe NIM came out and said, hey, we're gonna restrict credit and increase the price of credit for borrowers that are borrowing

for an investment property or a vacation home. And especially if you know, if that vacation if you're trying to refinance that vacation home, and especially so if you're trying to take cash out you know, on on every finance, and especially so if the loan to value ratio is high.

They kind of saw that there was a little bit of frath going on, you know, with with people trying to build you know, many real estate empires and you know, buy a bunch of properties to airbnb them, and and they said, hey, no, no, no, this is this is not what these institutions are for. We don't want to encourage this. So we're gonna we're gonna actually restrict how much money you know, we're gonna give you. We're gonna

make that money more expensive. But they can't, you know, just change the price from like one day to another. They have to give you a certain amount of notice. And there's customs in this market. And so they said, you know, any loan that is, you know, delivered to us after a certain date, like you know, we're gonna pay less for if it has any of these characteristics.

And you know what happened was that, you know, originators talked to their perspective borrows and said, hey, you know, let's get these loans done right now, because they're gonna they're gonna shut the faucet off. And sure enough, as we saw in April numbers and we saw the origination and balanced. So the Feds out of the market because it's winding down its balance sheet and we probably wouldn't

expect it to start buying up nbs anytime soon. Probably the banks are out of the market for the various reasons that you describe duration, risk, interest rate volatility, A lot of them are in the process of rebuilding up their capital levels, especially potentially ahead of a recession and

some loan losses going up. What's the trigger for the big buyers to come back and start buying mbs again and maybe start to bring that spread down or is that just not going to happen anytime soon and we're gonna, yeah, we're gonna be stuck with a new normal of higher interest rates or higher mortgage rates, I should say. So, let me just fill in this one buyer that we haven't talked about yet, and that is going to be your highly leveraged balunce sheets. And this this is essentially

hedge funds and mortgage reads. And I guess what, you know, we could call shadow banks. I hate using that term because it's kind of, you know, become associated with. Yeah, it has connotations that that I don't particularly agree with. But you know, these are institutions or you know, operators that want to behave like banks in terms of you know, participating in having a maturity mismatch and a liquidity mismatch and earning that spread and using a lot of leverage

to achieve it. But they also don't want like the regulation that comes with like being a bank and the costs associated with being a bank. I think the one that is most visible in the market is mortgage rates, right, and and they basically borrow a bunch of money by a bunch of mbs, do some hedgen they can't be like completely unhedged, and then whatever the spread is, you know, to take a big fee for themselves and then they

pay the rest of the villain. And these instruments are you know, pretty popular with current yield focused investors and like income focused investors, and they've been a sizeable participant, right And so as long as repo is reasonably easy to get and it's not too expensive, and there's a decent spread between where you borrow and the yield you get, they're out there. You know, they're participating in this market buying those bonds. Some of these rates are you know,

effectively captive to loan originators. I'm not going to name names because I don't want to make anybody mad, but you know a lot of these originators are in the business of originating these loans and immediately selling them to a read that is associated with the same management. And as long as you know the book value was underneath the share price. They were very active in issuing you know who shares, thereby raising more capital and thereby, you know,

being able to increase how many bonds they bought. And that trade is broken. Now there's not you know, there's not enough yield left. Repos is harder to get and it's one of the reasons that things are very difficult for this product is because using mbs as collateral for a loan is a lot harder and more expensive than

using investment grade credit level of treasuries. I was going to ask just on this point, I mean, why can't you do what every major financial player seems to do when it comes with a liquid bonds and just put it in like an E t F wrapper and improve margins on it that way. That is the question that I was hoping you would ask. E t F s need to track a reference basket. And as we've mentioned, and you know we talked about earlier, this is a market that is full of individual securities that are not

funcible and they're not liquid. A lot of times a particular bond will only have one owner for its entire life. That makes it particularly unsuited for wrapping around you know, wrapping it in an e t F. The other part of it is that, you know, we do have some ets that folks some mortage backed securities. They don't really get a lot of flows. Whoever the end user is of e t F s seems to want either investment grade credit or government bonds. There's really very little appetite

for mbs wrapped in an e t F product. I can speak as to why, but you know, I do monitor the flows pretty closely, and we just don't see that. So I just have one last question. And you know, one of the things that's going on right now that we talked about on our last housing episode is there's been this big affordability shock and so you know, no one wants to buy homes at these levels. Probably not a lot of people want to sell. Expectations that you

just have this like very frozen dormant market. The monthly payments at these prices, and these mortgage rates are just like way too high. Do you see finance innovating beyond here? Like could we see a fifty year mortgage, could we see a hundred year mortgage? Or other things? Or maybe the return of like you know, non fixed rate mortgages

come back in popularity after a long time dormation. Yeah, like we'll be talking about like are we going to see the return of like finance finding ways to lower that monthly cost for perspect of home buyers. Unfortunately, not an adjustable rate product works when you have a steep yield curve. But you know, right now we're we have a pretty flat yield curve, and so you know, if you're paying you a rate based on the short rate,

that's not going to be great. The market might be a little bit reduced because people are less worried about the duration, but it's not going to help that much past thirty years. Increasing the immortization time doesn't really reduce the monthly payment. We've we've had attempts at you know, doing forty years pretty recently, and it just doesn't help lower the monthly payment. The thing that helps lower the monthly payment is bringing the spread down, and you know,

having rates at a lower level. And I just want to clarify when I talk about the NBS spread, you know, I'm talking about the spread between uh, you know, a generic mortgage backed security and by generic, I know I just said that this product is not fungible, but you know, we're talking about the products. It's called t b A stands for to be announced. It essentially product that hasn't

been delivered to the market yet. You can think of it as like futures for nbs, and that is you know, at the highest level, and you know, probably about twelve years. You know, if we use the you know, last week's rates it was about one it's about the same today. That's really really high. A year ago that rate would have been you know, about eight basis points. And so you know, we've seen about you know, one percent added

to a borrowers page just from that spread. But apart from that spread, you know, we also have the spread that is captured by the g c s and that's increased, not much, but it's increased by about five basis points. And there's also originators, right, Originators have to make money, and part of you know, what they make is that the difference between what borrowers pay and at what level they sell the loan to Fannie Freddie. And you know, we've seen that go up, you know, depending on the week.

It's pretty volatile, but you know between fifty basis points there, which brings you to something that I think you guys will find interesting. And I don't think enough people are paying attention to Originators make money based on how many dollars of volume they put through, right, so their costs are tied to the number of loans that they process.

Loan originators their main costs as out of like you know, like office space and whatever is that they have, you know, these loan officers and you know, and their assistance, you know, chase borrowers, making sure that they have all the paperwork, making sure that you know, they're getting everything in before the deadlines. It's a very call centered type of job, making sure that you know everything is according to the rules.

And those costs are kind of like on a per loan basis, but the money that they make really is based on like how much dollar volume they do, and

so you know, bigger loans mean more profits. And last year and the year before that, they were you know, they were doing many many loans, but they were also doing like bigger loans, right, and you know, because they have this incentive to write you a bigger loans so they can make more money, they would remind you, hey, you know you're doing every finance I see that you know, you're you know, dropping the rate that you're paying from you know, three point five to two point seven five.

You know, you new lower payment that turncome drops and you know, would you like to borrow against your existing home equity? And a lot of people said, you know yeah, And we had an incredible amount of equity withdrawn from housing, you know, about a trillion dollars last year. We had a decent sized chunk this year. That's also you know, when you think about like wise inflation so high, you know, where's all this money coming from? All trillion came out

from that way. So they were employing a lot of people doing this, right, And now you know, we've had the amount of dollars that flow through these originators declined by more than half. You know, we were seeing in some months two d and fifty billion dollars you know, being originated and now we're closer to a hundred and well there's just not that much work too, and and you know, you want to keep people around because like, well, what if the business comes back, right, you want to

be able to ramp up. But you know, one of the things that we are likely to see is, you know, this is a commission based business. And so as the flow drives up and the commissioner's dry up, there's gonna be some attrition and staffing. And then what you're gonna see is something similar to what we saw in where in the second half when everybody was rushing to refinance and mortgage, originators said, you know, we don't have enough

people to handle this loan pack line. So they, you know, they did what anybody else in that situation does, and they raised their prices and they you know, they kept a larger amount of you know, the the coupon that the borrower is paid. And so as we go through this slowdown lending, we're likely to see attrition to this

quote unquote supply chain of lenders. And if pressure rates were to come down again, that doesn't necessarily mean that, you know, the rates available to borrowers are going to come down, because in that case, originators are going to have enough pricing power to defend their unit economics and keep a larger portion of that coupon. You know, I love it when guests come on the show and talk about incentives, because there are a bunch of incentives at

play here. There's the incentives of banks like choosing exactly what to put in their portfolio, or big investors making the choice between treasuries versus mbs, but the loner senators as well. Well, I was just gonna say, this is a supply chain episode, because what you're describing, or what you described, is the physical like literally not even a financial but the physical capacity to process all this paperwork.

And I remember when it was really constrained in early because rates collapsed, but you know, there was just this flood, and so there was like this sort of like physical constrained like a supply chain. Anyway, I think that's like a fascinating point that and now as you say, it's gonna ripple and we're gonna have like hollowed out supply chains that will keep mortgage rates even higher if rights

come down, and it doesn't just happen in originators. Everybody loved complaining about prepayments, but prepainments keep this industry allowed. It kept massive amounts of flow going through the system. It keep you know, originators employed, It kept appraisers employed,

It kept people on the south side employed. It meant that you know, if you were on the buy side, and you know you were buying all these billions of dollars worth of products and it's like rapidly prepaying and you have to you know, kind of recycle that money and kept those traders employed. Generally, more flow is good, there's more to do. People in this business love to

be big accounts. It helped and helped with that. You know, you were saying, hey, you know, I'm doing like X amount of business with you, and that X was like a very big number that kept doing. The good graces of the South Side kept your coverage happy, you know, salesman for for bonds, especially on the primary market where you know, they always had lots of products and there

was always buyers for that product. So everybody got said by this refinancing and pre payments flow and that disappeared, you guys reported Bloomberg reported recently that you know, BMO cut of their staff, and Wells Fargo has been cutting the people that they have associated with this, and I can tell you from from talking to people that have known for for ten or fifteen years, it's it's tough out there. People used to have a steady source of clients.

You know that we're pretty reliable buyers of new issues every month, and suddenly they're just not there. They're not present. There's more supply on the secondary market from you know, these fund out flows that we talked about, and from level balance sheets that have to reduce their leverage because higher interest rates and less favorable borrowing conditions have made it on economic for them to hold this paper. It's not good for for anybody. And so we're going to

see attrition in the origination space. But we're also going to see attrition on the cell side, you know, whether that involves sales or structuring or trading. You know, by structuring, I mean the trenching of these securities into into different risk profiles. All right, Germa, we tease this episode by saying we were going to go into detail on what's going on with the MBS market, and you definitely delivered

on that promise. So thank you so much. Really appreciate you coming on odd lots, even though you said on Twitter that you would never do at Yeah, you weren't going to go on a podcast. I meant that. I meant that, but then but then you DM me and you know, and I talked to I talked to Power Sin and I was like, I don't really love doing media, and he's like, but it's OK, you can't say no, and I said, I know, I can't. I can't say no. We got to leave this part, and no one shouldn't

say no. That was so good I learned. That was so helpful. Now I actually understand your tweets. All right, thank you, Thank you guys. So Joe, well, first of all, I would never give you a mean look. I rolled my eyes with love. Okay, thank you that. It makes me feel better. Feeling pretty down for the first few minutes. Sorry,

but I thought that was a really interesting conversation. And so first of all, you know, it's not it doesn't happen that often that someone comes on and says a market is essentially broken, or it used to happen a lot more when the FED was in various markets and everyone would come in and say, oh, it's broken or distorted, But then the FED left, and now people don't seem to be talking about that as much. It was so good.

That answered so many questions. I mean just started like I told you, you know, I did not always understand like why if we have Fannie and Freddie or Jinnia may backing mortgages, like why can't we just get mortgages at four percent, like the treasury if they're if they has the government guarantee. So that was just really helpful understanding like why now in particular, the spread is so high in part but there are obviously many reasons because of like sort of the cost of that option going up,

because of course everyone wants to refinance. The question do you asked about the natural bus so much good stuff there. Well, the other thing I would say, I know, everyone's interested in the mortgage market because it's house and people are

interested in housing. But the other reason I find this so interesting is it's sort of a microcosm of some of the more like structural critiques that you're starting to hear about about who's going to be the natural buyer for all types of bonds, so not just mbs, but also things like treasuries, other government bonds. I mean, we just had a massive kerfuffle with guilts in the UK.

And so if you think that because of all these changes, because we were in this new era of higher interest rates, higher interest rate volatility, that's going to lead to structurally higher spreads, then that basically means like that's kind of a drag on growth and a dragon returns potentially. I was looking while we were talking. I was like looking at some like mortgage reads on the term or just the price. I just don't do it so brutal, if

you know. Also, I love that last point, and I remember that from like early because right, like rates collapse and so if you have a house, you're like, yeah, I want to refight, right, but everyone to doing it, So then you know they lacked the capacity, and so then they charge more because they're like, well, if you want to get through, if you want to have our workers do the paperwork, you're gonna have to pay more.

And then they hire a bunch of people and then it's like okay, then you're late when the spread collapses because they have no pricing power anymore. So it really like this idea that like there is this like finance supply chain where it's going to say, by people, So fascinating. We managed to turn a highly technical financial markets episode into basically a supply episode as a quintessential odd lots episode. All right, shall we leave it there, Let's leave it there. Okay.

This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway and I'm Joe Wisn't all. You can follow me on Twitter at the Stalwart, follow our producer Carmen Rodriguez at Carmen armand also check out the odd Lots newsletter if you go to Bloomberg dot com slash odd Lots. Tracy and I we write every week. We don't talk about it enough, do we, Tracy, No, we actually write

quite a lot. So you can get summaries of the interviews, you can get transcripts, you can get other things that Joe and I find interesting. Plus the weekly newsletter that also includes reading recommendations from some of our guests are going to be anyway. Yeah, check it out. Just check it all out at Bloomberg dot com slash odd LODs, and of course you could check out all of the podcasts Bloomberg onto the handle at podcasts. Thanks for listening