Sonya Morris: Moving on to mortgages, it seems like the view of the U.S. housing market is mixed. We've got some managers telling us that we're starting to see a bottom here, other managers are still pessimistic, think there's chances of further defaults. What's your view on the mortgage market?
Mary Ellen Stanek: Sure. When you look at the fundamentals of the U.S. consumer, certainly it's challenging. High unemployment levels, leveraged personal balance sheets. At the same time, the biggest asset typically on individuals' balance sheets is their home. That value has come down and eroded. Certainly in their retirement accounts, their stock holdings, and their portfolio values came down in the last year, particularly in a pretty extreme way in 2008, early 2009.
So when you look at those fundamentals, you can get very negative about what the outlook is for the consumer, particularly the residential mortgage-backed market.
We step away and we look at a couple of other things. We go, all right, that market has suffered a great deal already, values are down a lot, now from here sequentially how do we see it improving? And not every market we believe is in a bottoming process, but most are starting to form a bottom.
And we think at this point, when you look at data like affordability of mortgage payments relative to overall income levels, we're actually seeing quite affordable levels, and some of the most attractive levels we've seen historically.
One of the most powerful dynamics is low interest rates. And if you think about what the Fed has tried to do by bringing short rates down to near zero, and by trying to get mortgage rates down, it allowed for both refinancing and well as more affordability. Because that interest rate is such a powerful dynamic in the affordability question.
So we step back and put it all together and say the market certainly overall might be challenged in certain geographic areas, particularly where there's extreme levels of unemployment, like a Michigan where you've got greater reliance on the auto industry and the auto suppliers.
But when we pull it all together, we look at it and we say the affordability side is quite attractive and we are in a bottoming process overall. And as we move through the last couple of months of '09 into '10, we will continue to see improvement.
Morris: The other factor in that is the Fed's participation on the agency side. How does that affect what you're doing in the funds?
Stanek: Sure. Great question. What happened a year ago, really '08 as we moved through it, was there was a lot of selling pressure that started. Some of it was by leveraged investors who were forced to start selling. And there wasn't a lot of buying demand coming on the other side.
Into the extreme post-Lehman, there were no buyers. The market, really people just pulled back. Even if you had liquidity, you were concerned, you pulled it back. You didn't know how, necessarily, far this could go or how long it could go.
And so what did the federal government do? They established a number of programs. Unfortunately they had to establish a number of programs, it seemed like every week, every few days, and continue to bring them on.
We took that position at the time that this was a massive, colossal problem systematically that we had, and it was met by a colossal response on the federal government.
And so as you look at it all, you look at very directly certain parts of the market where the Fed became the buyer or the Treasury became the buyer, and put their own balance sheet in, most importantly in Treasuries, in U.S. government agency debentures, and as you suggest, in the agency pass-through market. Which has created a situation where those bonds are trading very rich, relative to their historic valuations.
We would under-emphasize at the margins some of those positions. Because we just look at 10-year average valuations and say they've maybe come a little too far. And why? Because we've had, some would say, this medication, this unusual buying power, this unusual demand coming out of the federal government.