My Mortgage Blog

An article in the Saturday New York Times made the unexpected assertion: “Bonds Backed by Mortgages Regain Allure.”

What hops—like a disease-bearing flea, perhaps—into my mind is a seemingly obvious question: If the mishandling of mortgage-backed investments was a principle cause of the recent years of recession and financial dislocation, how could it be that we are diving back into those investments? In fact, in what way are we diving back into them and who’s doing the diving?

It gets even more intriguing. The Times cited Greg Lippman, who made money in the past as the mortgage market rose in a frenzy of investment-creation and trading, and then again a few years later as the mortgage-backed investment lost incredible amounts of money—in effect, first making money by investing in favor of the real estate market’s near-term future, then by investing against it—is now making money by investing in the very mortgage-backed bonds that he had made investment bets against.

Not a very loyal investor, you might say, but that has been the way to make a fortune in recent years, often investing against your last investments. So, Mr. Lippman’s investment portfolio at his new firm, LibreMax, is now “heavy with subprime mortgage securities” (as Azam Ahmed writes in The Times).

Is this indicative of a world that has lost its rational footing, or does it tell us something about the recovery of the real estate market? Both, I suspect.

The investment in existing mortgage-backed bonds (there aren’t really many new ones being written at the moment, but there may be in the future), given that the purchase prices today are very low, can generate a better return than today’s Treasury securities even if rates don’t fall further. (We’re generally talking 2% to 5% yields, which are still difficult for me to get very exercised about.) Prices of existing mortgage-backed bonds, therefore, “have risen more than 15 percent in the first two months of 2012, after dropping by as much as 40 percent last year.”

And yes, the growing interest in mortgage-backed bonds does indeed reflect a growing confidence in the real estate recovery. But there is another side of this double-edged sword. As before, the value of these bonds is nearly impossible to fix until it has been established by a sale. We’re still dealing with a lot of guesswork, and that means the perceived risk level can quickly rise through the ceiling if, among other possibilities, troubles in Europe (whose banks still own a lot of mortgage-backed bonds) threaten to force banks to sell their holdings, ripping into the value of the bonds worldwide.

So what the investors in this market are suggesting by their actions is that the recovery in the real estate market is worth betting on. But they are also suggesting that the very investments that were instrumental in bringing on the recent recession and near-collapse of investment banks now represent a good bet.

As Jeffrey Gundlach, a founder of DoubleLine Capital, said recently, “To believe that this time we are really out of the woods and the prices will not drop again is dangerous.” Indeed.

After calls for investigations of the largely unregulated mortgage-backed bonds, perhaps people like Michael Lewis, in his The Big Short, and Gretchen Morgenson, who has been writing about the mortgage fiasco in The Times for years, have been doing the most valuable investigating. All we seem to have are politically-embattled hearings and a strange effort to decide on appropriate fines for major banks, who will not acknowledge any wrongdoing.

In other words, perhaps the main message the return to mortgage-backed bonds has for us is that we’re moving on—for better or worse—without really taking advantage of a lengthy pit stop in which the markets and investment vehicles could have been studied and repaired somewhat, giving us a mortgage market that functions more safely and appropriately in accordance with the needs of those who take out the mortgages to purchase their homes.