Real Estate News & Commentary

Mortgage REITs – The Next Savings & Loans Crisis?

Expertise: Mortgages & Creative Financing, Personal Development, Real Estate News & Commentary, Real Estate Investing Basics
46 Articles Written

Recently Federal Reserve Chairman Ben Bernanke decided to consider “tapering” off the massive amount of money the Fed has been printing to buy up mortgages. The news threw the market in for a shock. After all, if printing massive amounts of money has not spurred the economy the way it was supposed to, why isn’t Bernanke printing even more?

Want more articles like this?

Create an account today to get BiggerPocket's best blog articles delivered to your inbox

Sign up for free

Okay, I'll stop being so snarky. The point is, the signal the Fed supposedly gave have caused recent interest rates to rise in mortgages, Treasuries, and even municipal bonds. It seems as if the police have started knocking on the door on the endless cheap money party. Undoubtedly the Fed has just caused some major havoc across the financial world, but let's just for now focus on mortgage REITs.

Mortgage REITs

Mortgage REITs (real estate investment trust) seem to be a relatively recent phenomenon. Mortgage REITs were established back in 1960s but it only recently grew extremely popular. These REITs invest in residential and commercial mortgage backed securities guaranteed by Freddie Mac and Fannie Mae.

Their main way of making money is to use short-term debt to buy longer-term mortgage securities, earning the spread between the rates. For example, if a 30-year mortgage backed security is earning 3.75% but the mortgage REITs can borrow short term at 2%, then the REITs can make a spread of 1.75%. And by adding leverage to the mix, the REITs can make even more money.

Thanks to the massive quantitative easing the Fed has undertaken, the mortgage REITs have been able to make a lot of money because all of a sudden their cost of borrowing short term funds have dropped tremendously. The nearly free money allowed these REITs to earn a relatively good returns on investing in long term mortgage backed securities. And since they are barely regulated, their ability to nearly leverage themselves to the hilt further increases their earnings.

The Connection to the Savings and Loans Crisis

I haven't lived through the savings and loans crisis, so correct me if I am wrong, but aren't mortgage REITs just like S&Ls? S&Ls back then took in short term deposits and made long term loans. The swift rise in short term interests destroyed the entire industry since the cost of capital surpassed the rate of returns. Could the same be happening with the mortgage REITs as well?

Mortgage REITs as a whole now have assets of over $400 billion. That is a huge chunk of money. And they are all heading for danger right now given the fact that interest rates may continue to rise. Frankly, I don’t like their reactions right now. What mortgage REITs executives have been saying is that, “so our spread is thinning? That’s okay. We will be taking on MORE leverage so we can earn more money.” Doubling down on shaky grounds? Oh boy.

Realistically, I do not think Bernanke would really have the courage to raise interest rates. The whole world’s economy has been bent out of shape by easy money and no one is going to want the party to stop. Sudden increase in interest rates (or should I say, a return to normality?) would decimate many investments and the economy as a whole that have been so used to cheap money. Mortgage REITs would be one of those industries in danger. If these REITs collapse, then there could be forced liquidation of billions of mortgage back securities. Are the taxpayers going to pay for that as well? And if it happens will it again slow down this “magical housing recovery” we’ve been having?

Photo: trackrecord

By Leon Y.
Leon Yang is an active real estate investor in Las Vegas. He is a buy and hold guy who also likes to flip from time to time. His main passion is to t...
Read more
    John Thedford
    Replied over 7 years ago
    I have been watching some of these REITS for some time. It appeared people were making a lot of money with them. There were some making well over 15%. I see they have taken a pretty big hit recently. Glad I didn’t buy into them!
    John Thedford
    Replied over 7 years ago
    Let me add they are often referred to as MREITs to identify their type of investments rather than just REITs.
    Replied about 7 years ago
    The Fed is in BIG trouble. If they stop buying bonds rates are going to skyrocket. 1 trillion dollars of stimulus a year is not only normal but vital to our economy to keep the “dream” alive. The stimulus drives down rates and enables our government to have less interest expense at 16 trillion than it did at 8 trillion. Crazy. The Fed is the only one buying treasuries, if they stop the gig is up. No one will be willing to take 2% return on US treasuries and as they rise so will mortgage rates. EVERYTHING is based on the 10 year treasury price. And the ten year treasury price is a lie!!!!!
    Kyle Hipp
    Replied about 7 years ago
    Rates will rise gradually as the FED tapers off its buying. However there are many others that are buying treasuries other than the FED. If you look you will see that the average treasury auction is over subscribed 3 fold. This means that the sells $50 billion in treasuries on a tuesday they have $150 billion in willing buyers. As QE operations wind down it will need to be managed correctly and there will be bumps but I can assure you the end of America is not around the corner.
    Replied about 7 years ago
    Kyle, thanks for the response. I agree that its not the “End of America” I’m not a doomsday guy. Here is my logic… Lets assume its general knowledge that if the Fed stops buying treasuries, rates will rise. Lets even say buyers only see rates as rising gradually like you said. Well, if I own a treasury bond and I know rates are going to rise, then by understanding how bonds work I know the value of my bond is going down. Lower value = higher yield, lower yield = higher value. Ok so now with a reasonably basic understanding of the market I know that my bonds are going to be worth less (not worthless… well maybe 🙂 ) in the future than they are now. I will lose money. I don’t really care how “gradually” I lose my money, I’m going to lose it all the same. Obviously I am going to sell. Treasuries are in high demand for several reasons, 1.) a 30 year bull market has made treasuries the worlds go to safe haven 2.) Japan and Europe are a complete mess. And most importantly 3.) THE FEDERAL RESERVE IS ARTIFICIALLY BOOSTING DEMAND AND THUS PRICES. As a savvy investor I know not to fight the Fed. If they are going to buy 40 billion of bonds a month, then bonds are good place to be, and investors flock there. Without the Fed, it is not a good place to be and all those $150 billion in willing buyers are no longer there. The key to remember is that the fed is buying bonds to enable government deficit. If rates went to 5% which is not unreasonable at all, government interest payment would go from $340 billion a year to $850 billion (on 17 trillion). The average maturity for government debt is five years. Meaning they have roll there debt over to these higher rates in the not too distant future. I’m glad you are optimistic, and correct me if my logic is wrong, but yikes!
    Replied about 7 years ago
    Great job on this one once again Leon!