And what rough beast, its hour come round at last,
Slouches towards Bethlehem to be born?
William Butler Yeats, The Second Coming
That is the sound of alarm bells ringing inside my face. The warning signs come from the bond and fixed income markets. And on three fronts, the signs are ominous. More debt. More risk. More likelihood that we are slouching toward a monetary endgame. The mechanics of wealth destruction – inflation or deflation – are somewhat irrelevant if the destruction of your wealth is inevitable.
Making it not inevitable is the task of Capital & Conflict. But before the endgame is the second coming of the mortgage-backed security, and this time with an ETF twist.
BlackRock has launched an EU-listed exchange-traded fund (ETF) that tracks the US mortgage market. The fund actually tracks – or is designed to track – a Barclays’ index of US mortgage bonds. That index is made of bonds issued by government sponsored entities Fannie Mae, Freddie Mac, and Ginnie Mae.
It gets better. Or worse, depending on your experience with securitised mortgages. Those government sponsored entities are able to issue debt with an AAA rating. The proceeds of that debt are used to buy up mortgages in the secondary market (the primary market being where a local or regional bank makes a loan to a homebuyer). Thus does the US housing mortgage ride again! And thus is risk-taking enabled by a thin veneer of creditworthiness.
Please note that I said Fannie, Freddie, and Ginnie are government sponsored enterprises. That gives them the implied – but not explicit – backing of the US Treasury. Their bonds are rated AAA because investors believe they are backed by the full faith and credit of the American government – or would be if push came to shove. That’s why there’s an appetite for these bonds; because of the so-called risk-free rate of return on government bonds applying to mortgage-backed bonds.
All of which is a long way of saying that in the hunt for yield in a low interest rate world, securitised American housing mortgages are back, baby! And in Europe, you can “get exposure” to them with an ETF. Do you see what this means?
To me, it all sounds a little like a lovely old spinstress going on a first date with Hannibal Lecter, only she doesn’t know they aren’t going to dinner. She doesn’t know that she’s the dinner. And by the time she finds out, he’ll be three forkfuls into her hard-earned savings. Am I exaggerating the risk here?
Maybe. After all, it’s perfectly rational for income-seeking investors or retirees to look around for higher yields, even in the mortgage-backed bond market. But the risk they have to take in order to get those yields is not a risk most people can afford to take in their retirement years. In a world with normal interest rates, it’s not a risk you’d even dream of taking.
Category: Market updates