Fed’s coronavirus response left mortgage market ‘high and dry’

Jefferies chief market strategist David Zervos believes one area that the Federal Reserve has “left a bit high and dry” in its recent emergency moves is the residential mortgage market, something policymakers should aim to fix.

Since the pandemic gripped the world’s economy, the Fed has thrown trillions at the market in the form of various initiatives designed to bolster markets and key sectors of the economy. Zervos, himself a Fed alumnus, thinks the housing sector could benefit from some of the central bank’s recent largesse — especially as recent data suggest it’s increasingly under duress.

Residential mortgages have suffered from “a real lack of focus by the Fed,” the strategist told Yahoo Finance in an interview. He said lending standards have improved since the financial crisis, which was triggered by a housing meltdown.

“They fixed it, but, you know, the AAA pieces of non-agency residential mortgage bonds are still 200-plus over. You could say the same in commercial as well, although they did address that somewhat,” Zervos stated.

“But they’re only focusing on the agency markets, and that really doesn’t help very much the homeowner. Just by driving up secondary prices for mortgage pass-throughs — we saw this last time — it doesn’t get a lower rate to the household,” he added.

Zervos, who worked as an economist and advisor to the central bank, credited the Fed for its pivot to Main Street, but emphasized that mortgage holders need more attention than what they’re getting.

While small businesses have gotten support, “what about the guy that’s got a mortgage that’s at 4%, 5%, 6%, still in good credit…has a job or has refocused and got a new job, and he’s trying to get a lower rate or refinance his house with these new very low-interest rates?” Zervos asked.

Meanwhile “the bank is saying, ‘We’re not interested.’ And that’s really what the banks are saying because the origination machine is largely broken,” he said.

Zervos added that the Fed “could come in very easily and fix that. And I think their next step — my personal bet is their next step is something in the residential mortgage market.” 

As the central bank pays more attention to small businesses, refinancing a large swath of household mortgages can have a massive impact on their image, the economist added — provided it’s done the right way. 

“And I think focusing their stimulus efforts on buying secondary is just going to backfire like it did last time,” Zervos told Yahoo Finance.

“And so my guess is they’re looking at it…because it could be a lot of stimulus. If you get 100 or 200 basis points lower on mortgage rates for people, whether it’s short term or long term —15-year, 30-year, or some sort of adjustable structure for a while, you can really help people out,” he added. 

The ‘haters’

Amid criticism that some of the Fed’s moves are reactionary and could make the problems they’re trying to solve even worse, Zervos said he partially agrees with the “Fed haters.” In particular, some critics have taken aim at the central bank’s purchases of high-yield exchange-traded funds. 

“We’re not really doing anything to help mom and pop get a lower loan on their $250,000 or $350,000 mortgage. But we are now basically giving funding to the levered loan space, for example, or the highly-levered [high yield fund] structure, which happens to have, I think, still five or six companies in it which have declared bankruptcy, and they’ll be moving out of the index, but they’re still in there,” he said. 

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Zervos insisted that backstopping “the high end of the capital structure” like mortgages is more in keeping with the Fed’s mandate.

“And it’s got plenty more of that high-end capital structure to work within places like the residential mortgage market before it needs to go in and buy high-yield and equities,” he added. “So I’m somewhat sympathetic to that.” 

Julia La Roche is a Correspondent at Yahoo Finance. Follow her on Twitter.