Monday, January 12, 2009

Huge decline in mortgage yields and spreads

This is unprecedented. Since the end of October, the yields on FNMA mortgage-backed paper have fallen over two and a half percentage points, to an all-time low of 3.42% today. Yields on the reference 10-year Treasury have fallen one a half percentage points over the same period. The spread is almost back to "normal" levels now. All that is missing is for 30-year fixed rate conforming mortgage yields to fall to 4.5%, but that should follow shortly.

Several things are at work here. On the one hand, yields are unbelievably low in general because the market is convinced that deflation is going to be with us for many years. On the other hand you have the Fed, which is promising to keep short-term interest rates close to zero for a long time time; this effectively forces people to move out of cash and into longer-term and riskier investments in order to pick up yield. And then there is the fact that the Fed is now buying mortgage-backed securities directly (though in such relatively small quantities that I don't think that can explain the bulk of what has happened). Finally, we can't ignore the fact that the demand for mortgage loans must be weak, at least relative to the desire of investors to own mortgage-backed loans.

If anything is going to dispel the deflationary gloom that seems to pervade the market, it's things like this. Refinancing activity is already up significantly, and will likely rise much more. New applications for mortgages are up a bit, but should rise considerably in the months to come. We have two powerful forces converging—sharply lower mortgage rates and steadily declining home prices—and I don't think the savvy American homebuyer is going to fail to take notice of the arrival of an opportunity of a lifetime. People respond to incentives, and I would be very surprised if we don't see a bottoming in housing prices before summer.

8 comments:

Bernard said...

I am willing to bet the majority of people do not have the 15-20% necessary for a down paynment on a home and that while the decrease in risk measures is a good thing, they mean nothing to the average non home owner at the moment...

Scott Grannis said...

I think you are probably right, but mainly re high-end home prices. They are going to be the next ones to fall significantly.

Eldon Mast said...

Scott,

I really enjoy your blog and your writing. The charts that you create usually punch home the point. And the chart in this article is no exception

I am placing a link on my blog to yours as I am sure that my readers will enjoy your material as much as I do.

Eldon Mast, Editor
The Good News Economist

Brian said...

I have a friend who is an appraiser here in TN. He's been getting personal calls from homeowners begging him to raise his valuations. These are all high-end homes with balloons coming due, and the drop in values mean these folks can't get the re-fi and are facing foreclosure. As he described it - 1/2 mil homes with trimmed lawns and owners making $200k a year, yet headed for repossession. They never dreamed the values would drop and erase their equity...

Scott Grannis said...

Eldon: Thank you!

Scott Grannis said...

I remember 15 years ago having a conversation with a colleague about how the government was distorting the housing market (mortgage interest deduction, non-recourse loans, no prepayment penalty, Freddie and Fannie). But we never dreamed it would end so badly. Nor that the party would go on for another 12 years.

Gene Prescott said...

According to Bill Bishop, author of The Big Sort, rural housing prices have held better than urban:

When the House Bubble Burst, Rural Prices Kept Steady
01/07/2009
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The country is going into contortions to deal with the collapse of the housing market. The collapse took place in the cities, not in rural communities.

http://tinyurl.com/79jknq

Scott Grannis said...

And it was the cities where prices rose the most. The problem is getting fixed rapidly.