Nancy Trejos of the Washington Post reports
that the spread between conforming and non-conforming mortgages has now gapped
out to 75bp, from 20bp in mid-July. Tyler Cowen says
in response that
If you think this is only a liquidity event, there is of course a profit
opportunity.
I’m not entirely sure how Tyler expects me to proft from this spread. Can I
buy an RMBS of non-conforming jumbo mortgages while going short a Fannie Mae
bond with a similar duration? That would imply that non-conforming jumbo RMBS
are trading at levels equivalent to where new jumbo mortgages are being priced,
which is not necessarily the case. A lot of the rise in mortgage rates is an
attempt to scare borrowers into not borrowing at all, and we saw
with Bear Stearns that primary-market rates can be well wide of secondary-market
rates.
More generally, you need liquidity to profit from a liquidity event. If illiquid
paper plunges in price, you can buy it up (with cash), hold it to maturity,
and make a tidy sum. But where’s that cash going to come from? That’s the question.