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Mortgage bankers are sounding alarms that the Federal Reserve’s emergency purchases of bonds tied to home loans are unintentionally putting their industry at risk by triggering a flood of margin calls on hedges lenders have entered into to protect themselves from losses.
In a Sunday letter, the Mortgage Bankers Association urged the U.S. Securities and Exchange Commission and the nation’s main brokerage regulator to address the problem by telling securities firms not to escalate margin calls to “destabilizing levels.” The MBA, whose members underpin the housing market, asked the watchdogs to issue guidance directing brokers to work constructively with lenders.
The rally in prices for mortgage-backed securities that’s been fueled by the Fed’s large-scale buying is “leading to broker-dealer margin calls on mortgage lenders’ hedge positions that are unsustainable for many such lenders,” the trade group wrote in its letter to SEC Chairman Jay Clayton and Financial Industry Regulatory Authority President Robert Cook.
Finra declined to comment. An SEC spokeswoman didn’t immediately respond to emails seeking comment outside of normal business hours.
The Fed initiated its bond purchases earlier this month as the spread of the coronavirus hammered financial markets, causing liquidity to dry up and prices to plummet as the typical buyers of mortgage-backed securities fled. The pain mortgage lenders are now facing from their hedges shows that government intervention can trigger unintended consequences.
The MBA letter, signed by Chief Executive Officer Robert Broeksmit, said that when lenders issue new loans, they often simultaneously short mortgage-backed securities. This is done because the loans might fall in value before a banker can sell them to Fannie Mae and Freddie Mac. The bet against mortgage bonds helps protect the lender if that happens, Broeksmit wrote.
Now, with lenders getting crushed on these hedges, they’re facing a wave of demands from brokers that they sell holdings or put more money in their trading accounts.
“Broker-dealers’ margin calls on mortgage lenders reached staggering and unprecedented levels by the end of the past week,” Broeksmit wrote. “The inability of a large set of responsibly-managed lenders to meet these margin calls would jeopardize the very objective of the Federal Reserve’s agency MBS purchases — the smooth functioning of both the primary and secondary mortgage markets.”
A surge in margin calls is also inflicting major pain on commercial real estate with the threat of widespread loan defaults prompting a wave of selling of commercial mortgage-backed securities. Colony Capital Inc. CEO Tom Barrack on Sunday called for a moratorium on margin calls and Fed buying to halt the sell-off for bonds tied to commercial properties.
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