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QE2 may be coming but will a mortgage pricing war follow?

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As mortgage rates move lower and expectations of a second round of quantitative easing, or QE2, rise, analysts at Bank of America Merrill Lynch (BAC) said banks may begin a race to a new pricing bottom to gain more market share. Federal Reserve Bank of New York Executive Vice President Brian Sack hinted that the Federal Reserve will soon begin to purchase mortgage-backed securities as part of quantitative easing and larger economic stimulus. Thanks to these and other statements, banks have put away their fear for higher rates, and reports have trickled in of new hiring in origination departments. Since 2006, mortgage employment has fallen from 494,000 to 244,000 at the end of the second quarter of 2010. According to the report, the top-three originators hold 51% of the origination market share. And with higher expectations of QE2, the banks will begin pushing prices lower to gain even more. JPMorgan Chase (JPM) analysts recent raised its odds of the Fed buying mortgages over the next six months from 10% to 50%. "Oligopolies have a way of breaking down due to competition and aggressive price cutting, driven by the perception of the oligopoly members that a unique opportunity to garner market share in a strong demand environment has been presented," according to the BofA Merrill Lynch report. "That moment has not yet arrived, but with each move lower in rates, the moment draws closer. The battle lines are very slowly being drawn, through capital raises and staffing increases, for a price war." Analysts went further to say that the pricing war may not occur in 2010, it might emerge at the beginning of next year. This will mean a tough road for Agency mortgage-backed securities investors as the sector will see heavy refinancing from the lower rates. The next refinancing wave would be generated by ever-shrinking Treasury rates, and would likely produce new mortgages that could never be refinanced again because of lower rates, analysts said. "The prize of securing the lion's share of this asset will go to the lender who most aggressively lowers rates, loosens credit standards and brings in the most borrowers," according to the report. Write to Jon Prior. The author holds no relevant disclosures.

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