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As Ben Bernanke burns the midnight oil at the Federal Reserve he could do worse than fit in a couple of games of Jenga. This game involves the creation of a tower using wooden blocks, each piece of which must be carefully removed from the structure without triggering the collapse of the whole. The cessation of $40 billion of monthly asset purchases from the agency mortgage-backed securitization market will require similar dexterity if it is not to trigger the collapse of the entire market – the primary conduit through which the Fed has conducted its engineering of interest rates since the financial crisis began. Bernanke must be all too aware that as he attempts to slowly taper the Fed’s MBS buying, he risks taking the fragile US housing recovery with it.
The initial signals are not encouraging. Ten-year treasuries were 1.62% before Bernanke’s comments in May, but by mid-August they had hit 2.7%. In the mortgage market, rates quickly backed up by 100 basis points from 3.5% to 4.5% in June and Agency MBS 30-year dollar prices fell by 8bp. The impact on the mortgage industry has been savage.
