Federal Reserve Bank

Though trading conditions have weakened, the market for government mortgage-backed securities is still liquid according to researchers at the Federal Reserve Bank of New York. Bloomberg staffer Matt Scully reports that the spread, which indicates the state of liquidity based on the difference between MBS bid and ask prices, has remained stable since 2011.

The state of the mortgage bond markets is due to plummeting transaction volumes, which occurred at the same time that the Fed became the single largest buyer of agency MBS, acquiring $1.7 trillion of MBS since 2008 and causing a 40% decline in trading volume.

“Liquidity is still strong,” said David Finkelstein, chief investment officer for agency and residential mortgage-backed securities at Annaly Capital Management Inc. “Though it’s slightly dissipated because of the presence of a passive investor, i.e., the Fed.”

Some investors, however, have argued that dealers are becoming less willing to make markets and that liquidity has suffered as a result. Barclays Plc and Deutsche Bank AG, for example, are among mortgage-bond dealers scaling down their activity as the Fed’s presence in the market makes it more difficult to turn a profit. Mortgage-backed securities are the primary funding source for U.S. mortgages. A serious decline in liquidity could lead investors to demand premiums on the bonds, which would ultimately raise borrowing costs for U.S. home buyers, the researchers said.

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