By Isobel Kennedy

NEW YORK (MNI) – In the week ended October 26, the New York
Federal Reserve bought $5.5 billion agency mortgage-backed securities
under the program announced by the Federal Open Market Committee on
September 21.

The Fed continues to buy the paper mortgage originators are selling
into the “to-be-announced” or TBA market.

This week, the Fed bought $2.95 billion 30-year Freddie Mac and
Fannie Mae pass-throughs with 4.0% coupons for delivery in December. It
also bought $1.35 billion Fannie Mae and Freddie Mac 30-years with 3.5%
coupon for January delivery.

The rest of the purchases were made in 30-year Ginnie Mae
securities and 15-year Fannie Mae and Freddie Macs with maturities and
3% coupons.

This MBS purchase program stems from the decision made at the
September 20-21 Federal Reserve Open Market Committee meeting to begin
reinvesting the proceeds from its Agency and Agency MBS portfolios back
into Agency MBS.

The proceeds in its mortgage and Agency portfolios are derived from
the prepayments it receives monthly from the mortgages it holds and from
the maturation or coupon payments it receives from its Agency holdings.

Each month the NY Fed will estimate how many MBS it expects to buy
in the following 30 days. These figures come from the prepayment reports
received monthly from the housing agencies.

On October 13, the Fed said it expects to buy about $22 billion MBS
from October 14 to November 10. So far it has purchased $11.35 billion.

The Fed’s portfolio of MBS currently totals about $870 billion,
down from its peak in March 2010 of $1.25 trillion. The Fed’s agency
portfolio totals about $108 billion.

The bond market has been wondering for some time if the Fed would
have to embark on QE3 if the U.S economy does not begin to show some
life.

Luckily, the economy has indeed produced some better results of
late and with the European situation taking a turn for the better on
Wednesday it may never be necessary.

But recent Fedspeak from various officials has the markets
wondering if the Fed might resurrect its MBS buying program should the
economy need more stimulus. The Fed bought $1.25 trillion MBS in
2009-10.

Steve Abrahams at Deutsche Bank says the prospect of the Fed
returning to MBS market has good points and bad.

On the plus side, he lists:

1) Spread would likely tighten;

2) Dealers can buy from the originators with assurance that they
can sell to the Fed;

3) Lower rates end up lowering volatility as paper is moved from
the private sector that hedges to Fed that does not.

But there are challenges, Abrahams says:

1) Liquidity concerns if tradeable float gets smaller;

2) Complexity of unwinding such a large portfolio without raising
the cost of mortgage finance;

3) Risk of losing the attention of the private sector. More to
follow

He also says the possibility of a Fed role in MBS alters the asset
analysis for investors.

The Fed is not motivated by P&L, Abrahams says, “It is motivated by
inflation, employment and all the macro forces that drive those risks.
It makes its holdings and its plans transparent. It buys
programmatically. And it has capital limited only by US political
support for its balance sheet. That makes the Fed a powerful force to
reckon with. And it means that any analysis of value in MBS should
always start with a view on where the Fed might go next in the sector.”

** Market News International New York Newsroom: 212-669-6430 **

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