Risky mortgage debt hit by recession fear amid default concerns

Investors are offloading securities sold by Freddie Mac and Fannie Mae that shift the risk of mortgage defaults away from taxpayers, in a sign of growing concern about defaults if risking interest rates cause a severe recession.

The securities, referred to as credit-risk transfers, could incur losses if rising defaults find their way into the massive swaths of mortgage debt backed by the housing-finance giants. The Federal Reserve’s interest-rate hikes have shown signs of cooling the pandemic’s roaring real estate market, and many worry that the central bank’s inflation-fighting may cause a recession that hurts homeowners’ ability to repay their loans.

That has scared some investors who hold securities tied to uncertain cash flows from mortgage debt backed by Freddie and Fannie. Asset managers, hedge, and pension funds all invest in the nearly $60 billion CRT market, which behaves as insurance for the two agencies against defaults on slices of roughly $4.5 trillion of mortgages that would otherwise spell tremendous losses for US taxpayers.

Credit-risk transfers don’t come with that guarantee. Instead, they appeal to investors who desire to earn higher returns in exchange for the risk of losses if widespread mortgage defaults reach even comparatively modest levels.

Ben Hunsaker, a portfolio manager at Beach Point Capital Management, said CRT prices had fallen so much that judging by spreads alone, the market looks like it's preparing for a housing crisis as bad as the 2008 recession.