By Isobel Kennedy

NEW YORK (MNI) – The New York Federal Reserve announced Monday that
it would begin conducting coupon swaps on 30-year Fannie Mae
“to-be-announced” passthrough securities with a 5.50% coupon in order to
facilitate settlements with the primary dealers.

The swaps are likely to begin Tuesday. They will be restricted to
the 5.50% coupon and the amount is not to exceed $9.2 billion.

The swaps will be conducted competitively with the primary dealers.
The dealers will offer various swaps to the New York Fed and the Fed
will select which swaps it wants to execute. All prices will be
conducted at the market.

These operations will have no monetary policy implication and are
strictly meant to close out open trades that the primary dealers have
been unable to deliver to the Fed because of a shortage of securities.
The operations will make it easier for the street to deliver other
30-year MBS that are more readily available.

Following the announcement, the 5.5s cheapened compared to 30-year
4.5s and 4s and also vs. Ginnie Maes, sources said. The announcement
also affected 30-year 5s on some concern that Fed might decide to
conduct coupon swaps on that issue too.

In addition to the Fed’s holdings of the 5.5% coupon, market
sources stress that the open fails in the 5.50% coupon have also been
caused by heavy demand from other real money buyers.

And many Wall Street shops have been putting on up-in-coupon
recommendations so the supply of this coupon has been light. Also, these
coupons are less likely to experience prepayment risk due to credit
constraints and tight lending.

But one veteran said he does not think the Fed will do swaps on 5s.
“These coupon swaps on 5.5s will likely settle” the fails issue with the
Fed, he said.

Nonetheless, with a slew of 5.5s getting ready to hit the street,
fast money was said to be selling the coupon and the up-in-coupon trade
was under pressure.

Over the months, the Fed has made progress on the securities that
the street has been unable to deliver to the Fed due to a supply/demand
imbalance. The fails outstanding with the N.Y. Fed have fallen from $100
billion to $17 billion recently.

The New York Fed began purchasing mortgage backed securities in
January 2009 as part of the quantitative easing component of crisis aid.
The program ended on March 31, 2010 after the Fed reached its purchase
goal of $1.25 trillion securities.

The aim of the buying program was to support the housing market
amid a severe recession by keeping interest rates low and taking supply
of new origination out of the market.

With rates so low, however, originators were not producing some of
the coupons that the New York Fed was buying. In fact, new origination
has mainly been seen in 30-year 4.50% and 5.00% coupons for a very long
time. Hence, the lack of 30-year 5.50% coupons.

While the N.Y. Fed is doing its part to alleviate the delivery
gridlock, its open fails pale in comparison to all the open fails that
have been created by a supply/demand imbalance.

“Of course, $9.2 billion is relatively nothing compared to the $830
billion in outstanding fails,” says Walter Schmidt, mortgage strategist
at FTN Financial, “but it is a clear acknowledgement by the Fed of its
current influence on the state of the MBS market.”

The Fed can only do so much to help the overall fail picture in the
Street. Market sources note that a bulk of the large $830 billion figure
concerns what is called “round robins” where one shop is unable to
deliver because it itself is also failing to receive.

Market sources also said it was wise for the New York Fed to make a
clear, concise announcement of the swaps program and the reasons for the
swap operations.

“The mortgage market understands these swaps,” one veteran said,
“but the other bond markets do not.”

In other words, the N.Y. Fed wants to make sure the swap
announcement did not somehow get misconstrued by Wall Street as having
anything to do with monetary policy, quantitative easing or the
unwinding of quantitative easing, he said.

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

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