Real estate investment trusts that invest in GSE MBS have grown from $152 billion at yearend 2010 to nearly $400 billion, Stein said in a speech about risks in the credit markets.
These REITs buy agency MBS and “fund them largely in the short-term repo market in what is essentially a levered carry trade,” Stein said on Thursday.
Under the tax code, REITs must pay out 90% of net interest to their investors.
“If MBS yields decline, or the repo rate rises, the ability of mortgage REITs to generate current income based on the spread between the two is correspondingly reduced,” Stein said.
The Fed governor also pointed to other areas of the credit market that appear overheated. Analysts at Federal Financial Analytics contend that Stein understands that the “desperate” chase for yield is due to the Fed’s low interest rate policies.
“Since the source of this problem is the central bank, the cures he considers are also focused on the FRB, not market sectors like REITs,” a FFA report says.