But This Time IS Different—COVID Recession

Abstract

Earlier this year, the US economy dropped from historical highs to a severe downturn almost overnight due to the government’s response to the coronavirus outbreak. The pandemic affected all sectors of the economy, including the MBS market. Historically, there has been a direct link between an economic downturn and the fundamentals of the financial markets leading up to the downturn. As we saw in the Great Recession, the exuberance in the mortgage market, poor mortgage loan underwriting quality, and the exponential leverage resulting from the derivative markets contributed to financial disaster. The recent economic downturn resulted not from overleverage and the kind of ‘wild west’ behavior observed in the early to mid-2000s, but from the deliberate shut down of the US economy in an effort to mitigate the spread of the coronavirus. Unlike the Great Recession and the Great Depression, the events leading to the current economic downturn were exogenous to the market. As a result, the economy and the MBS market rebounded quickly. TOPICS:MBS and residential mortgage loans, financial crises and financial market history Key Findings • The forced shutdown of the economy resulted in an economic downturn paralleling the Great Depression. • Delinquency rates on residential mortgages and forbearance requests rose quickly, with a knock-on effect on MBS pricing and prepayment speeds. • Due to the strength of the economy and the MBS market pre-COVID, the time to recovery has been shorter than in previous downturns.