Table: How the Mortgage Market Affects Bonds
1 Homeowners take out fixed-rate mortgages that include the option to repay early.
2 Lenders package mortgages into securities and resell them. Mortgage-backed securities are now nearly 40% of the bond market.
3 Financial institutions buy them for the long streams of homeowners' payments. If homeowners refinance, those payment streams dwindle.
4 Interest rates fall, and homeowners refinance.
5 Institutions rush to replenish the stream of payments by buying 10-year Treasury bonds.
6 The Treasury buying pushes up bond prices, simultaneously depressing interest rates.
7 Lower interest rates stimulate more mortgage refinancing, and the cycle continues.