The Mysterious Rise of Mortgage Bond Prices in 2009: An Insight into Investor Behavior and Market Dynamics
The financial crisis of 2009 presented a curious phenomenon: despite the widespread belief that mortgage-bond-constituent mortgages were "all going bad," the price of mortgage bonds experienced a significant rise. This article explores the intricate dynamics behind this event, focusing on the role of investor expectations, market delinquency rates, and the recovery trajectory of the financial markets.
Understanding the Initial Market Freeze
The primary reason for the market freeze in 2008 and early 2009 was the realization that the mortgages backing the mortgage bonds (MBS) lacked true collateral. The "trusts are empty," as the article suggests, reflects the fact that many investors were misled about the legal rights and claims they believed they had over these assets. This issue centered around the "bogus documents" that were supposedly verifying the mortgages' health, leading to a significant skepticism and loss of trust among investors.
The Role of Expectations in Market Pricing
Prices in the financial markets respond to changes in expectations rather than absolute levels of expectations. This is a critical concept that explains the behavior of mortgage bond prices during the financial crisis of 2009. In 2008, prices of mortgage bonds plummeted as investors became increasingly pessimistic about the future of the economy and the market's ability to recover. However, by the end of 2008, there was a gradual improvement in economic indicators, which began to influence investor sentiment positively.
The chart below illustrates the recovery of mortgage bond prices during 2009. While prices continued to fluctuate, there was a significant upward trend from their nadir in December 2008. This trend was paralleled by a stabilization and gradual decline in mortgage delinquency rates, which had peaked at 11.53% in December 2009, but had returned to pre-crisis levels by the end of 2010.
The next chart demonstrates the delinquency rate on single-family residential mortgages during the same period. The graph shows a clear upward trend in delinquency rates, peaking in late 2009, but it also indicates that the majority of mortgages remained current, with 88.47% of mortgages being fully current as of their peak in early 2009. This demonstrates that contrary to popular belief, not all mortgages were "going bad," and many delinquent mortgages were either cured or sold, mitigating the losses.
Market Dynamics and Investor Behavior
The recovery of mortgage bond prices in 2009 was a result of a shift in investor behavior and expectations. While delinquencies were still high, the rate of increase had slowed down, leading to a moderate optimization in the market's perception. Investor confidence began to return as the economic situation stabilized, and the financial markets showed signs of recovery.
It is important to recognize that the price of mortgage bonds rises not due to the absence of any losses, but because the market anticipates these events. The significant recovery in prices in 2009 reflects the market's belief that the worst was over, and the recovery trajectory was gaining momentum. This belief was bolstered by the stabilizing delinquency rates and the overall improvement in economic indicators.
Conclusion
The financial crisis of 2009 saw a mysterious yet understandable rise in mortgage bond prices despite the perception that the underlying mortgages were "all going bad." The key to this phenomenon lies in the dynamic nature of expectations and the gradual stabilization of market conditions. As investors' confidence in the future of the financial markets increased, so too did their willingness to invest in mortgage bonds, leading to price recovery.
Understanding the interplay between market delinquency rates and investor behavior is crucial for anyone interested in the nuances of the financial markets. By recognizing the role of expectations in market dynamics, we can better navigate the complexities of the financial world.