In a recent post, we discussed using Recursion’s proprietary tools to unravel the Federal Reserve’s MBS holdings of Fannie Mae and Freddie Mac loans. The Fed’s holdings, however, are part of a bigger picture issue regarding the notion of “float” in the MBS market, that is, the amount of securities outstanding that are available to trade. The holdings of the central bank serve to reduce the float as the Fed is a buy-and-hold investor. These loans are said to be “locked up”. Besides the Fed, loans can be locked up in structured products, notably Collateralized Mortgage Obligations (CMOs). The first CMOs were launched by Freddie Mac as Real Estate Mortgage Investment Conduits (REMICs) in 1988 and allow cash flows to be tranched to meet the needs of different investors. Pools in CMOs’ collateral groups are also locked up.
In a recent paper, researchers at the Philadelphia Fed (Liu, Song and Vickery, May 2021) discussed the history of the differential between the pricing and the trading volume differential between Fannie Mae and Freddie Mac securities. Historically, Fannie Mae securities had traded ten times as often as those of Freddie Mac, with the consequence that trading costs for Freddie Mac could be twice those of Fannie Mae. In this paper they comment that Freddie Mac compensated for this by raising its g-fee, and by locking up its securities in CMOs.
Using the same recursive algorithms as in our prior blog, we can back out the CMO lockup, FED lockup and Float by agency:
By looking at the CMO lockup ratio between the two agencies in this manner, we can determine whether the convergence of liquidity and transactions costs observed by Liu, Song and Vickery after the onset of the UMBS required the support of a relatively higher lockup rate in MBS on the part of Freddie Mac relative to Fannie Mae.
The answer is clearly no. The lockup rate differential has virtually vanished, testimony to the success of the UMBS project.