Faith in Government or Faith in Reason?

Government backed mortgage securities are flying off the shelves. In contrast, private mortgage securities have sold at a discount. On the surface it may appear that investors are favoring the backing of the full faith and credit of the United States Treasury. On the contrary, I see investors chasing reason in regulation.

An increase in mortgage securities investment is a sign that the housing market really has leveled out. Other factors, like the income-generating nature of the securities have also attracted those looking for better returns than current market rates. But why are government backed securities so much more favorable than those offered by the private sector?

One argument is deep pockets. Even though the US economy has seen better days, it is still the best on the planet. The dollar remains the world currency. If the US defaults on its debt obligation, we all have a whole lot more to worry about that our mortgage bonds.

On the surface, that’s a good argument. But for years the public’s faith in government has been dropping. Over the past 2 weeks, approval ratings for all 3 branches of the Federal government have hit all-time lows.

So why are government backed mortgage securities seeing huge gains while their private sector counter parts are discounting their bonds?

Confidence in a return to reason.

Before the bubble burst, you could get a mortgage if you had a heart beat and a library card. Aggressive lending is exactly what collapsed the housing market.  It caused political blow back. It caused a lot of anger throughout the country. It cost trillions of dollars, and ultimately resulted in a ton of regulation.

The result we now see is a mortgage market where nearly 90% of residential mortgages are sold to Fannie Mae or Freddie Mac. Both of these entities have strict guidelines for loan approval. In contrast, guidelines for non-government insured loans are more flexible in their screening.

I am usually one to denounce government regulation. But in this case, the regulations are more than justified. They have caused the mortgage market place to return to common sense lending practices. Applicants are required to document their income, maintain good credit and put some of their own money into a purchase. Imagine that!

So when I see the difference between investment in government-backed and private mortgage securities, I see investors choosing reason in regulation. It’s a shame when the only way to instill confidence is through the regulation of common sense.

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