Bloomberg News

Fed Uses ‘Dollar Rolls’ in Mortgage-Bond Program Shift

December 09, 2011

(Updates with New York Fed comment in second paragraph.)

Dec. 6 (Bloomberg) -- The Federal Reserve Bank of New York entered into paired contracts to buy and sell mortgage securities for the first time since it began reinvesting in the debt in October, in a move that may reduce funding costs.

The so-called dollar roll transactions will “facilitate the settlement of our outstanding MBS purchases,” Jonathan Freed, a New York Fed spokesman, said in an e-mailed statement.

The central bank is purchasing bonds for December settlement and agreeing to sell the same amount of similar debt in January, said two people familiar with the matter, who declined to be identified because details haven’t been disclosed. Funding costs for mortgage-bond investors, which had risen in anticipation of banks trimming their balance sheets before year-end, fell after the Fed transactions.

“I applaud the Fed,” Scott Simon, mortgage-bond head at Newport Beach, California-based Pacific Investment Management Co., which runs the world’s largest debt fund, said in an e- mail. “This both makes them money and helps the MBS market. There wasn’t enough year-end balance sheet.”

The central bank began reinvesting proceeds from its holdings of $1.4 trillion in housing debt into government-backed mortgage bonds to help support the real-estate market and homeowner refinancing, shifting from additional purchases of Treasuries. On Nov. 30, the Fed joined with global central banks to cut emergency dollar funding costs for European lenders as the region’s sovereign debt crisis roils markets.

‘Funding Pressure’

The New York Fed says on its website that it “may use dollar roll transactions if needed to facilitate settlement” of its purchases. The Fed posts details on its mortgage bond buying each Thursday.

With dollar rolls, an investor seeking to borrow money enters into contracts to sell mortgage securities in any month and then buy similar bonds the following month; a lender would undertake the opposite trades. Investors entering into transactions for other reasons may be on either side of the contracts.

The transactions are similar to so-called repurchase agreement, or repo, loans.

The Fed’s latest move in the mortgage bonds may help “alleviate some mild funding pressure” in the market, said Bryan Whalen, co-head of mortgage bonds at Los Angeles-based firm TCW Group Inc., which oversees $120 billion in assets.

The implied cost of dollar-roll financing for some of Fannie Mae’s securities rose earlier yesterday to more than 40 basis points, depending on prepayment-speed estimates, according to Whalen. That compared with 27 basis points for similar repo loans, he said. A basis point is 0.01 percentage point.

Backstop Role

That disconnect “implied a little bit of stress” in money markets, he said. “It’s typical to see this type of mispricing of liquidity” around year-end, and Europe’s crisis is exacerbating the situation, Whalen said.

The implied cost of dollar-roll funding for Fannie Mae’s 3.5 percent 30-year securities fell to between 10 basis points and 20 basis points, depending on prepayment assumptions, early today, according to Credit Suisse Group AG analyst Mahesh Swaminathan. It had increased about 25 basis points since the end of October, he said in an e-mail.

The “Fed’s move to buy dollar rolls underscores their backstop role to support liquidity in the market,” Swaminathan said. “I don’t think they are going to do these regularly. It is something intended to be done only when liquidity is perceived to be low.”

--Editors: Pierre Paulden, John Parry

To contact the reporters on this story: Jody Shenn in New York at jshenn@bloomberg.net; Caroline Salas Gage in New York at csalas1@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net.


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