Cheap money era that saved housing seen bottoming

, Bloomberg

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The era of increasingly cheap money that fueled the housing recovery and record home-lending profits is showing signs of ending in the mortgage bond market.

Fannie Mae-guaranteed 3 percent securities, which lenders use to price new loans, tumbled last week to the lowest since Sept. 12, the day before the Federal Reserve announced plans to add $40 billion of mortgage debt to its balance sheet each month. The drop, as lawmakers struck a budget deal and the central bank signaled it may conclude the open-ended bond-buying program this year, could lead to further increases in homeowner borrowing costs from the record lows set in December.

"It would present a test for the housing market just as we're going into the key spring selling season," said Mark Vitner, a senior economist in Charlotte, North Carolina at Wells Fargo & Co., the top U.S. mortgage lender. "I wouldn't wind it down when it is poised to do its most good."

While no one expects mortgage rates to skyrocket, higher rates could challenge the rebound in U.S. residential real estate after a five-year slump by cutting how much homebuyers can afford to pay. Rising borrowing costs may also "spoil the party" for lenders that profited from a more than 20 percent jump in mortgage originations last year, according to Deutsche Bank AG, by slowing refinancing that's benefited firms led by Wells Fargo and JPMorgan Chase & Co.

Bond investors should also anticipate reduced returns, according to Pacific Investment Management Co. Bill Gross, manager of the world's biggest bond fund said in a Jan. 4 interview on Bloomberg Television that bets on mortgage securities "are over in terms of the capital appreciation."

Mortgage Profits

Banks and savings institutions posted $25.3 billion in mortgage-banking profit through the first nine months of 2012, or 24 percent of their $106.8 billion total earnings, according to data compiled by Bloomberg from Inside Mortgage Finance, an industry publication, and the Federal Deposit Insurance Corp.

Lenders' fattened margins appear to be already contracting as they seek to maintain volumes by absorbing some of the costs of lower bond prices rather than passing them on to borrowers, according to broker Brean Capital LLC.

Government-backed mortgage securities slumped last week as U.S. lawmakers on Jan. 1 agreed to a budget plan that averted the so-called fiscal cliff, which would have meant more than $600 billion of spending cuts and tax increases. The deal reduced tax hikes that could hurt economic growth while maintaining spending that boosts the supply of Treasuries. Bonds could slump again if Congress fails to cut "material expenses" as it continues to address the deficit, Deutsche Bank analyst Steve Abrahams wrote in a Jan. 3 report.

Lower Yields

Bond market losses accelerated after the minutes of a December meeting of Fed policy makers released Jan. 3 showed several of them saw its $85 billion in monthly bond purchases as likely to end sometime in 2013, with some divided between a mid- or end-of-year finish.

The Fed had said after its Dec. 11-12 meeting it would hold its separate target for short-term borrowing costs near zero "at least as long" as the unemployment rate remains above 6.5 percent and inflation projections are for no more than 2.5 percent.

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