The primary dealers' net long exposure to mortgage-backed securities has skyrocketed by $33 billion in recent weeks and may be an early indicator a market crisis is looming, according to a recent report from Lehman Brothers.
The 22 primary dealers seem to have a net long exposure of more than $40 billion to mortgage-backed securities, according to Lehman. Its researchers are basing this conclusion on data from the Federal Reserve. Just six weeks ago, the dealers had a net long exposure of $7 billion and while dealer exposure has increased across the board, nowhere has it done so as sharply as it has in the MBS sector. In the past, steep shifts in exposure have been precursors to market crises, said Lehman. The firm was not more specific about what kind of crisis could ensue. But as a result, it is now recommending a strong underweight to MBS. "In the past, a sharp increase in net dealer positions have coincided with some market crisis," Lehman wrote. Srinivas Modukuri, head of MBS research, could not be reached for additional comment by press time.
To be sure, just because the dealers may have concentrated their bets is not necessarily a bad thing. "The big institutional funds need paper right now--that's why inventories have been beefed up," said Bob Williams, an MBS trader at Clark Capital Management, a small institutional dealer. In fact, primary dealer demand for mortgage paper may be healthy for smaller players because it provides a strong bid. "At least it's creating liquidity, the other way would be a lot worse," he noted, adding "they could have the right bet on."
