Speaking of Duration Mismatch

I wonder if we are setting ourselves up for another set of problems for Fannie and Freddie. They are purchasing large number of mortgages with 5 percent interest rates; so long as the yield curve remains steeply sloped, this is OK. But if short term rates rise to 5 percent, the GSEs and investors in their MBS who are borrowing short will be in trouble.

The problem is that the GSE disclosures are not very helpful. They look at the effect of changes in interest rates and the slope of the yield curve on value, but the changes are quite small. They also disclose how much of their debt is one year and how much is longer than one year, but again, one year is not that helpful a cut-off point. It is possible that everything is fine from a duration perspective, but with so much current focus on credit issues (and just getting through the next year), we may be taking our eye off the ball on interest rate risk.