Due to the role they played in spawning the recent global financial crisis, mortgage-backed securities are viewed by many as “portfolio poison.” As individual and institutional investors looked to dump these securities last year, the federal government was “forced” to acquire a huge MBS position. With signs of a sustainable recovery popping up, the Fed has reportedly begun considering ways to unwind this massive position, a policy move that could have a big impact on prices of MBS ETFs in coming months.

Despite some attractive yields and backing from agencies of the U.S. government, most investors have been hesitant to buy up these securities, opting instead for less risky fixed income products. When the Fed’s decision to cut borrowing rates to almost zero failed to thaw frozen credit markets, they adopted additional emergency measures, buying up almost $1.5 trillion of government-guaranteed mortgage related securities and Treasuries. As the Fed’s balance sheet swelled, this demand helped to drive prices up and yields down.

Just saw this post on Zero Hedge about a downgrade of a recent Re-REMIC issue by Standard & Poor’s. Re-REMIC’s are repackaged mortgage-backed securities of a supposedly more secure pedigree as they were to have been constructed of securities identified to be of better quality and thus less likely to default.

Now, just 4 months after the issue of these securities, S&P has downgraded them citing “significant deterioration in the performance of the loans backing the underlying certificate” and referring to said deterioration as “severe”. How in the world are these ratings guys staying employed? More importantly, how in the world are the investment bankers finding buyers for these issues?

Since spiking from 4.8% to nearly 5.8% in June, the national average 30-year fixed mortgage rate according to Bankrate.com has stabilized in the 5.25% to 5.35% range. With the Fed Funds Rate at 0%-0.25%, potential home buyers would love to see mortgage rates decline more, while the banks lending the money would love to see spreads increase (bottom chart) so they could make more money.