During the crazy days of the housing bubble in 2006, bankers created a bond called MABS 2006-FRE1. The instrument gave buyers the right to payments on the subprime housing loans of nearly 2,000 borrowers, including Stephen Monzione, a professional wedding photographer in New Hampshire.
Six months after the security was issued, a trader called it a “crap bond.” Monzione, with a monthly income of about $900 and mortgage payments of $927.22, eventually stopped paying. So did hundreds of other people. The bank that originated the loans went bust. The bond’s value crashed to 16 cents on the dollar.
Today, the subprime bond is rising from the ashes. The subprime borrower isn’t.
A hedge fund manager in Colorado snapped up MABS 2006-FRE1 last summer and more than doubled his money in four months, thanks to a surge of investment into financial markets by the Federal Reserve.
The U.S. central bank hasn’t been as helpful to Monzione. The 60-year-old lost a foreclosure battle and must be out of his home by the end of July.
“God bless them,” Monzione marvels at the traders who flipped the bond of which his loan was a part. “I don’t have a clue about what the hell that means to me personally.”
Monzione has put his finger on a strange disconnect. Some 57 percent of borrowers’ loans in MABS 2006-FRE1 are delinquent by 60 days or more, but the bond came roaring back nevertheless. Curiously, its recovery had little to do with the real-world fates of the individuals behind the bond.
The seeming paradox is one of the consequences of the Federal Reserve’s policy of “quantitative easing” – an attempt by the U.S. central bank to help spur the economy by buying assets to generate huge volumes of cheap credit. The Fed campaign has been under way since the crash of last decade’s housing bubble – which itself was inflated by a prolonged period of easy money meant to alleviate an earlier crash, the stock swoon of 2001.
The Fed’s current program is indeed helping matters greatly, by shoring up banks and lowering the borrowing costs of corporations and home buyers who have good credit. But it is also giving rise to unintended consequences: new asset bubbles that are mostly benefiting well-heeled investors.
Under the third and latest round of its stimulus, nicknamed QE3 by traders, the Fed each month is buying $40 billion worth of high-quality mortgage securities (and $45 billion of longer-term Treasury securities). The idea is partly to drive interest rates lower on home loans, and partly to prod investors into other kinds of risk-taking activity that can create growth. Home loans are indeed cheap and sales are firming up in much of the United States.
But the Fed is also encouraging speculative fevers. Its massive purchases of mortgage securities have driven prices so high, and yields so low, that investors have scampered into riskier securities – like the MABS 2006-FRE1 bond. Thanks in part to the Fed’s bond buying, the value of subprime bonds – a $300 billion market – jumped 21 percent between last spring and this March, according to Amherst Securities.
Fed Chairman Ben Bernanke’s overarching goal in playing the bond markets has been to stabilize the financial system and maximize employment. He has tripled the central bank’s asset holdings since the peak of the financial crisis in September 2008. The Fed said last week that it would increase the purchases if needed to shore up the economy.
Quantitative easing, however, is a blunt instrument that can do little to directly help people at the bottom of the economy. Such aid is easier to deliver through fiscal policy and legislative relief – for instance, jobless benefits or debt-reduction programs. But as the Fed has been stepping up its stimulus, federal and state governments have been cutting spending. Corporations have been hesitant to invest and hire.
As a result, the recovery is spotty. The unemployment rate in April was 7.5 percent, the Labor Department said Friday. That’s down from a high of 10 percent in 2009, but the number of people with jobs still hasn’t recovered to pre-crisis levels.
“It’s what we call a fundamental detachment,” said Anthony Sanders, professor of real-estate finance at George Mason University. “The Fed is quite good at generating asset bubbles—just not the kind we want in the economy.”
A Fed spokesman declined to comment.