It looks like the Federal Reserve is finally going to pull the last rug out from under the US real estate and mortgage market once and for all. To be quite frank, this real estate bubble party had to come to an end sooner or later, right? Artificially propping up the mortgage markets that are hell bent on going down to the depths of economic hell is a plan that is made to fail. 

It appears that most of you in real estate/mortgage la la land do not comprehend the significance of this move by the Fed. Corporate media is only glossing over this devastating news as so called mortgage experts have not even realized that this is the biggest piece of mortgage news in several months. The US Real Estate Titanic is going down right now as many obliviously party and watch the band on the deck.

Why such gloom and doom?

The Federal Reserves program to buy billions of Mortgage Backed Securities (MBS) from Fannie Mae and Freddie Mac will officially end in March. The ripple effects that this will have on real estate, mortgages and on the market for government bonds will be absolutely devastating to the US economy.

Once the Fed stops buying mortgage-backed securities at the end of March, it will be up to the private market participants to buy these risky MBS. They will be the only ones left to prop up a rapidly failing real estate and mortgage market. Uncle Fed will no longer be the markets keeper (or should I say sucker) like it has been for economy safe keeping since the crisis began three years ago.

As the Fed pulls out from purchasing MBS, we should see mortgage interest rates rise significantly through spring. Home purchases will plummet and many, many of the remaining players involved in the real estate or mortgage business will fall like dominoes.

The volatility that this may bring on could eventually lead to the final crash of the markets. Higher interest rates may encourage hedging by private firms in the Treasury market and  that hasn’t really been happening because the Fed was gobbling up billion of dollars of MBS as the market was tanking. This will further exasperate the uncertainty in the mortgage markets with investors. Thus causing a wave of panic as Wall Street participants began to pull their money form various firms involved in the business of real estate or loans.

When the Fed pulls out in March, watch the bubble go pop or should I say KABOOM?!

Reuters reports:

“In essence, the Fed has taken a lot of volatility out of the marketplace,” said William O’Donnell, the head of U.S. Treasury strategy at RBS Securities in Stamford, Connecticut. “Any subsequent mortgage issuance is likely to fall into the hands of portfolios likely to be somewhat dynamically more hedged. It’ll have the prospect and almost the certainty of adding volatility back into the rates markets.”

The practice is known as convexity hedging. Investors holding MBS can actually find themselves losing money if mortgage or interest rates rise suddenly and they cannot get rid of their lower-yielding securities. They often try to offset unexpected increases in mortgage and interest rates by selling Treasury notes.

“If you look at option prices presently, we have the implied volatility for longer-dated options trading 25 percent over their long-term historical levels. One could argue the reason for this is that people anticipate uncertainty after March 31 end date of the Fed’s MBS program.” said Harley Bassman, a managing director at Bank of America Merrill Lynch.

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