A panel of top financial regulators is targeting mortgage real-estate investment trusts as a potential risk to the U.S. financial system, the latest example of Washington's growing concern with market bubbles.
Next week, the Financial Stability Oversight Council, a panel comprising the top U.S. financial regulators, is expected to cite mortgage REITs as a source of market vulnerability in its annual report, according to people familiar with the matter, a distinction that could set the stage for stricter oversight of the industry.
Eager to avoid the mistakes of the past, regulators are attempting to identify overly frothy activity before it poses problems. Even though the economy continues to recover only slowly, regulators see potential bubbles forming in a range of financial markets, in part because of the Federal Reserve's easy-money policies, which have driven interest rates to near-record lows and prompted investors to seek higher returns elsewhere.
Fed official William Dudley says mortgage REITs merit attention.
Mortgage REITs, which are publicly traded financial companies that borrow funds to invest in real-estate debt, have seen their assets quadruple to more than $400 billion since 2009. They differ from traditional REITs in that they invest in mortgage debt, rather than actual real-estate like office buildings or shopping malls. The firms take advantage of inexpensive, short-term borrowing to buy mortgage securities backed by Fannie Mae FNMA +0.38%and Freddie Mac, FMCC -0.26%and offer returns to investors of as much as 15%.
Is anyone familiar with the FSOC annual report? I wonder if the mREIT warning within will just be a small chapter in a very long novel (and maybe a chapter that hasn't changed much from how it appeared in past annual reports, assuming it was there too)...
They join leveraged loans and money-market mutual funds as areas of risk cited by officials. Three Federal Reserve officials have singled out mortgage REITs in recent weeks, saying the industry merits watching.
Calvin Schnure, vice president of research and industry information at the National Association of Real Estate Investment Trusts, said that rather than a source of instability, mortgage REITs have been essential to the housing recovery.
."Mortgage REITs have tripled their holdings of agency mortgages over the past couple of years because their access to public markets positions them to put new capital into the housing market," said Mr. Schnure.
The heightened scrutiny stems from the growth of such companies as Annaly Capital Management Inc. NLY +1.42%and American Capital Agency Corp., AGNC +0.06%whose assets have ballooned to more than $100 billion apiece over the past three years. The market capitalization of the industry has grown over the past three years from $22.1 billion to $59 billion, according to KBW Research.
"Mortgage REITs are bigger today, but they are bigger by virtue of an increased capital base," said Wellington J. Denahan, chairman and CEO of Annaly Capital. "Many of us have operated through challenging markets, including the financial crisis, and we continue to support and are helping to implement the regulatory changes that are being put in place to make the markets safer for all participants. This low-rate environment poses risks that investors in every market must be prudent about managing. In general, the mortgage REIT sector does so through a range of hedging tools, like interest-rate swaps, reducing leverage and conservative balance-sheet management activities."
The recipe behind their rapid growth is raising red flags in Washington, where regulators worry about the REITs' exposure to interest-rate spikes, reliance on leverage and short-term funding agreements that can dry up in times of crisis.
I'd agree that mREITs bear intensive regulatory scrutiny. Not all of them can be cleanly hedged and honestly managed. It's the nature of finance that slobs and crooks disguise themselves and blend into any crowd that seems to be living clean.
However, many mREITs are solid players. They have good assets, they follow the rules, and they hedge against the obvious risks.
They aren't like the CDO flippers, who created CDO-squared, CDO-cubed, etc., eventually ending up with securities that had the paintjob of a CDO but the risk profile of a baby sleeping on a pile of flaming glass.
Their sole risk is compression and inversion of the yield curve. But that's what the hedges are specifically designed to hedge. So their sole risk is far less risky. But now there's a new risk: that some dimwit with a badge will misinterpret their risk profile and institute some artificial barrier to maintaining profitability.
So, Mr. Regulator, as much as I like your work with the USDA and FDA and SEC in general, maybe this time you just take a look-and-see attitude, and get bristly only when you see something plainly stupid or illegal happening.
I think we've generally understood that QE would eventually end. Then we have the knowledge of the "leak" of the Fed's March minutes. Now regulators have an itch to scratch. It seems everyone has been warned.
somebody please explain the systemic risk. if AGNC failed tomorrow, nobody but shareholders gets hit. all the mortgages are still good. all of the loan counterparties get to walk away with a suitcase full of mortgage securities.
I think the risk is to liquidity because if mREITs get hammered by a rapid rise in interest rates and some become insolvent then the ability for Fannie Mae and the like to sell their loans could be greatly diminished and this would make it harder for people to get loans. This in turn would cause real estate prices to fall and economic activity to follow suit because many people spend their equity or spend based on the perception of their net worth which for many is the equity in their home. Many people zero out their credit cards when they refinance and this usually relaxes their attitude about how much they can spend. This may not be as much of a house of cards as selling loans to poor people who have no ability to pay them back or not even the intension to pay them back but it should not be ignored.
Forcing mREITs to lower their leverage might be wise if it is justified by possible interest rate scenarios. I don't think we all understand everything that can impact inflation as the latest flash crash of gold seems to indicate that little sparks can lead to major adjustments. I for one would appreciate it if someone starts running simulations on this stuff and looks for possible instabilities.
Financial crashes are like avalanches where the snow keeps building up on a slope until one too many snowflakes lands on a drift and it collapses under the weight. Sometimes you set off explosives preemptively to prevent an uncontrolled avalanche.
I just read the book “Currency Wars: The Making of the Next Global Crises.” The author seems to think that we are in a pretty unstable financial situation world wise. It is pretty hard to figure out how to survive the some of the possible scenarios that we could be headed for. I think the recent gold action probably cured most people of thinking that owning gold was the way to make it through safely. Now what? People need a place to live so owning apartments might work but then what if they can’t pay their rent?
Mr.wizzard it appears the risk is some might get a low enough entry point than they deserve :) I would like a nice entry point also but I want post drivel to get it. I do regret that AGNC may be included in the S&P 500 because of its possible effect on the Dividend run.
Hey Pharma -
I'm looking at all this FOSC attention to mREITs' as free Marketing, such that it will attract new investors and current longs will benefit from short-term bounce in the PPS.
You know, the glass is always half full :-)
All The Best,