Thursday, December 4, 2008

Mortgage rates are collapsing -- great news for housing

As this chart shows, the spread between mortgage rates and 10-year Treasury yields has been exceptionally wide for most of the past year. Falling yields for Treasuries did not translate into an equal decline in mortgage rates, because all spreads were widening. That in turn owed a lot to fear and uncertainty, particularly the fear, in this case, that the U.S. government might abandon its implicit support of mortgages issued by Freddie and Fannie. What if housing really collapsed and foreclosures overwhelmed F&F's ability to comply with the principal guarantee on FNMA and FHLMC mortgage-backed securities?

Those fears are rapidly dissipating. First the Fed told us they would be buying MBS directly. Then Treasury started talking about a program to buy mortgages issued by F&F at rates like 4.5%. At the very least this talk reinforces the notion (and builds confidence, which is the crucial variable) that mortgage-backed securities are not about to go up in smoke. Confidence begets confidence, and cheap mortgage money makes everyone feel better about the prospects for housing prices. Fixed rate conforming mortgages should soon be available for less than 5% given the 4.1% yield today on FNMA current coupon bonds. If Treasury yields hold at 2.5% and MBS spreads decline to more normal levels, then the rate on conforming mortgages could decline to 4.5% or even lower.

As I mention in my previous post, it is looking more and more like a bottom in housing prices is on the near-term horizon. Start looking for properties to buy: with a 4.5% mortgage (3% or less after tax for most folks) it's hard to imagine that you could lose money buying a house tomorrow that, in some areas of the country, sells for 40-50% less than it did 5-6 years ago.

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