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Without an Act of Congress, Mortgage REITs Could Face a Ruinous Year

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In a speech on Friday at the annual meeting of the American Economic Association, Ben Bernanke looked back at the Federal Reserve under his leadership and discussed the central bank's future plans, as well.

Bernanke reaffirmed the Federal Open Market Committee's commitment to keeping short-term interest rates low as long as the national unemployment rate remains above 6.5% and inflation doesn't float over the Fed's 2% mark. He noted that those factors were not "triggers," and reaching one or the other wouldn't necessarily prod the committee to begin raising the federal funds rate.

Reaching either of these thresholds could prompt the committee to begin considering such a move, Bernanke said. If Congress fails to reinstate extended jobless benefits now that legislators have returned from the holidays, dumping 1.3 million persons from the unemployment rolls could cause the jobless rate to drop much more quickly than anyone previously expected.

A devastating scenario for mortgage REITs
For mortgage real estate investment trusts such as Annaly Capital (NYSE: NLY  ) , American Capital Agency (NASDAQ: AGNC  ) , and Armour Residential (NYSE: ARR  ) , this could mean big trouble. Last year was a tough one for the sector, as fears surrounding the Fed's timing for tapering its quantitative easing program caused plummeting share prices and book values.

Now that the Fed has decided to start a slow taper of the stimulus program with the advent of the new year, changing the unemployment picture can only increase the pain. There is a good chance that removing more than 1 million people from the ranks of the unemployed will drop the jobless rate by as much as 0.5%, as those people are no longer considered unemployed. The percentage could fall further as another 1.9 million lose their extended benefits by June. A corresponding situation occurred in North Carolina in 2013, when tens of thousands of people lost benefits, and the state jobless rate dipped by 1.4 percentage points. The possibility of the same scenario occurring at the national level is very real.

Though Bernanke said short-term rates would stay low for some time after the unemployment rate dropped to 6.5%, what might happen if it kept falling? The Fed would probably further decrease its monthly purchases of bonds and securities beyond the reduction of $10 billion that begins this month. It would also begin considering an increase in short-term rates, especially if the unemployment rate appeared to be steadily moving downward.

Speeding up the taper is likely to further erode book values, and diminishing dividends may disappear entirely. Since December 2012, Annaly's quarterly dividend has fallen from $0.45 to $0.30 per share, and American Capital Agency's has dropped to $0.65 from a robust $1.25. Armour has decreased its own monthly payout from $0.09 per share to $0.05, which it plans to hold steady for the entire year. 

It is likely that this scenariowould precede the hiking of short-term rates by several months. The majority of FOMC members have said that the federal funds rate won't rise until 2015, and then "only modestly" during that year. But that estimate coincides with an unemployment rate of 6.5% being achieved by the end of 2014, not several months earlier.

Needless to say, escalating borrowing costs is not a complication mREITs need right now. If emergency unemployment funding is not reinstated once again, 2013 could begin to look like a cake walk compared to the damage these trusts may be forced to endure during the coming year.

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Read/Post Comments (8) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 06, 2014, at 11:48 AM, jppaquin wrote:

    This is flawed reasoning at its best. If the Fed decides to raise interest rates because the unemployment rate is falling, it is because the economy is doing better and people are finding jobs. A technical fall of the unemployment rate due to benefits ending does not indicate any job creation, or people finding jobs! I trust that the analysts at the Fed can read data better than the author here...

  • Report this Comment On January 06, 2014, at 2:51 PM, GareyGreat wrote:

    The disclaimer says to be respectful with out comments, but with this article that standard is very hight.

    Who wrote this garbage? The author suggests that if Congress doesn't pass extended unemployment benefits then the unemployment rate would dramatically drop. She has not even taken a remedial economics course nor does she have a basic grasp of statistics. For unemployment benefits one needs to be actively looking for employment; so the people who are collecting benefits are already looking for work. There is no evidence to suggest a sudden stoppage of unemployment benefits causes a decrease in the unemployment rate.

    Don't get me wrong, I'm all for cutting benefits for people have been unemployed for 18/24/36 months. They are just living off the government dole. But to suggest a chain events that this action would cause an increase in interest rates is absurd.

  • Report this Comment On January 06, 2014, at 5:30 PM, ir4getful wrote:

    With due respect, throwing unemployed folks off the benefit train would not impact the unemployment rate as used by the Fed's monetary committee and would not induce a move toward higher short-term rates. Makes no sense.

  • Report this Comment On January 06, 2014, at 9:39 PM, scm68gt wrote:

    Jesus. Just how much do you guys hate the REITs? It doesn't matter what is going on .. it is ALWAYS a disaster for these companies. Yes, 2013 was not a good year .. but I attribute a lot of that to the talking heads like you. So look what is happening now. The REITs are selling below book and the big guys are buying back their stock. Get your heads out of the dark hole and face reality.

  • Report this Comment On January 06, 2014, at 9:59 PM, phileo72 wrote:

    I was scratching my head after reading and re-reading this post...I'm glad to see that others also see the lack of logic and reasoning!

  • Report this Comment On January 07, 2014, at 1:11 AM, Johnwells99 wrote:

    What a stupid article!

  • Report this Comment On January 07, 2014, at 8:04 AM, pgaz wrote:

    I have to agree with most of the comments I've read so far. From previous articles written by Amanda Alix, it is easy to see her position on extending unemployment benefits. This should not be politicized, but it will be a major distraction by the DNC in the coming months, taking attention away from the failures of Obamacare. During the height of the Financial Crisis of 2008, there was a humanitarian need to extend benefits. But now we are 5 years into a recovery and the federal program is becoming institutionalized. People EXPECT benefits to go beyond state limits and are planning accordingly. From personal observation of middle class friends on unemployment, they are in no rush to get a job they think is below them. Studies have shown that when an individual KNOWS his benefits are about to expire, he or she gets really serious about a job search. We are doing them a great disservice because the longer they are unemployed, the greater likelihood their job skills become stale and they then really will need to accept a lower paying/skilled job.

    If the economy is improving as the administration is telling everyone, then now might be the best time to terminate this program.

  • Report this Comment On January 12, 2014, at 4:39 PM, justthefcts wrote:

    So .. a bad economy when few people can afford to buy is bad for mortgage reits? I think this girl just wants attention.

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Amanda Alix

Foolish financial writer since early 2012, striving to demystify the intriguing field of finance -- which, contrary to popular opinion, is truly what makes the world go 'round.

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