I didn’t, but traders at Lehman Brothers did, even as Lehman itself was peddling mortgage bonds as sure-fire investments. Now the shorts are back, under a different name, buying up those same bonds at a discount and earning money. Nothing wrong with that – these guys were right in 2006 and if they believe the housing market has bottomed and want to put other people’s money back in it, good for them. There remain some risks though if I know my Washington, we taxpayers are going to end up subsidizing the bonds, again, and making these guys richer. That’s my guess, anyway.
Yet the tide could turn again and wipe out investors. Chief among the risks is Europe: the Continent’s banks still hold a significant amount of United States mortgage securities, and if they are forced to sell assets, it could wreak havoc on the market.
Washington is a question mark, too. If banks have to pay for loans they issued under dubious circumstances, it would be a home run for investors, who could receive full payment for a mortgage in a security they bought at a discount. But if borrowers whose houses are worth less than their mortgages are able to reduce their principals on a large scale, bond investors could suffer because the securities would be worth even less than they paid.
“As a money manager, you can’t close your eyes to that potential outcome,” said Jeffrey Gundlach, a founder of DoubleLine Capital, who has been buying mortgage securities since 2008. “To believe that this time we are really out of the woods and the prices will not drop again is dangerous. People made that argument a year ago.”
The mortgage bond market is a very different creature than it was before the financial crisis. For one, it is much smaller: very few residential mortgage-backed securities have been issued since the crisis. The market, at $1.3 trillion, is half the size it was at its peak and shrinks by an estimated $10 billion every month.