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Plunge in Mortgage-Debt Prices Signals New Risks in Bond Markets

Thursday, 31 Jul 2014 02:24 PM

Prices of a new type of U.S. mortgage bonds are plunging this month, teaching investors a lesson on the risks to markets wrought by the growing constraints on Wall Street banks.

The $8.2 billion of risk-sharing securities sold in the last year by government-controlled Fannie Mae and Freddie Mac can shift their losses from homeowner defaults to bond buyers. One slice of a deal issued in May traded at 95.7 cents on the dollar yesterday, down from 99.7 cents at the end of last month, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

With JPMorgan Chase & Co. analysts failing to see “any fundamental reason” for the tumble, investors from CQS U.K. LLP to Calvert Investment Management Inc. are speculating that the drop is mainly about the growing amount of the debt running into limits created by new regulations on bond dealers’ ability to smooth trading by building up their inventories.

“It could be symbolic of what could happen more broadly in a real ‘risk-off’ environment,” Bill Murray, a New York-based money manager at $14 billion hedge-fund firm CQS, said in an interview.

While investors are backing away from riskier assets across fixed-income markets this month, the Fannie Mae and Freddie Mac bonds saw some of the biggest drops. Prices of the largest junk-rated corporate loans have fallen to 98.6 cents on the dollar, from about 99 cents on June 30, according to the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 index.

Dealers ‘Disappeared’

As a few holders continued selling the Fannie Mae and Freddie Mac securities without an immediate emergence of investor demand, most of the dealers active in trading the debt “disappeared,” said Vishal Khanduja, a money manager at Bethesda, Maryland-based Calvert, which oversees about $13 billion.

Until recently, “everybody wanted to trade it: I think there were 10 to 12 dealers messaging me and looking to make markets,” Khanduja said in a telephone interview. “It’s partially indicative of the regulations’ impact on their balance sheets.”

Dealers have reduced their bond holdings in response to rules ranging from the international Basel III accord on banks’ capital, to the U.S. Volcker Rule limiting their ability to make bets with their own money. An expansion of Finra’s Trace trade disclosures to more types of debt is also increasing risks and cutting into profits for market makers.

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Prices of a new type of U.S. mortgage bonds are plunging this month, teaching investors a lesson on the risks to markets wrought by the growing constraints on Wall Street banks.
bond, markets, plunge, price
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2014-24-31
Thursday, 31 Jul 2014 02:24 PM
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