Why Are Mortgage Rates So High?

The premise of the question, “Why are mortgage rates so high?” is the belief that the spread between mortgage rates and treasuries is too wide based on the historical norm. Realtors are pushing for 4.5% mortgages for both purchasing and refinancing, and builders want rates below 3% for new home purchases. The builders say that special offers of 4.5% have not generated enough sales.

Bloomberg's recent “Mortgage Rates Left in Dust by Treasuries, Failures” cites foreclosure history and mortgage company failures as important factors in keeping Fannie Mae (FNM) and Freddie Mac’s (FRE) 30-year cost of funds close to 4%, while long term treasuries are yielding between 2% to 3%. The cost of funds spread has reached 1.4% versus a historic 0.14% over the last five years. The 30-year fixed rate conforming mortgage was still able to drop to 5.16%, certainly a generous offer to home buyers.

The cost of funds spread is indicative of many factors beyond the credit risk of home buyers and falling home prices. There are two main factors: First, treasury yields are unsustainably low. Despite the Fed’s commitment to keep rates low for several quarters, rates are especially low because of the transactional value and necessity of treasuries. Treasuries serve as collateral for many financial derivative transactions with cash being the only substitution. In many respects the Fed has little control over the actual value of treasuries. And without an explicit government guarantee, GSE debt will never substitute for treasuries.

Second, every government and industry official is telling us that the financial crisis is directly tied to the value of residential real estate. Stop values from falling, or even try to inflate them, and all will be well. But the market does not buy into the artificial inflation of home values through artificially low mortgage rates. The market does not believe that homes priced for mortgage money below 5% will maintain their values when mortgage rates return to reasonable values.

Long term recovery will only get started when homes are priced at values supported by mortgage rates sustainable over the next 5 to 10 years. Isn’t the market always forward looking?

Why isn’t our brain trust saying that we have a mortgage repayment problem and not a home value problem? I believe the reason is that we have a collateral based financial system, so increasing the value of collateral is the easy answer. Adjusting to lower collateral values takes more time than desperately trying to prop up values. And we are an impatient society. This has not worked and will never work.

Disclosure: Author is long FNM and FRE.

Comments

[Ishortyou:]

it depends on several factors, certainly the liquidity and trust on the market are a few of them.

2008 Dec 22 07:13 AM

[It Figures:]

You are overlooking another, unspoken, lender risk factor. Most in the incoming Congress and Administration have made it clear they believe it is good policy to allow courts to retroactively re-write mortgage contracts at the expense of lenders and in favor of borrowers when debtors become unable/unwilling to meet their obligations.

Should these re-writes become standard, all historic loss and recovery rules of thumb will become useless, and lender recoveries-in-default will decline. The way lenders protect themselves against this possibility is to further widen spreads against their cost of funds, to accommodate likely larger future loss/incident costs.

"Helping" today's struggling borrowers this way raises mortgage rates for all future borrowers. When policy changes increase lender losses, alert lenders - the only kind left- naturally build in fatter cushions to protect themselves and their profitability.

2008 Dec 22 08:21 AM

[Smalltownba...:]

Amen!

2008 Dec 22 08:24 AM

[Scott Sambucci:]

With mortgage rates already at historical lows, is dropping rates less than 100 basis points really going to spur demand? Probably not. In talking with hundreds of agents through my work, most agents will tell you that buyers are telling them - "I'm waiting for the bottom" not "Mortgage rates are too high."

I think you statement - "Long term recovery will only get started when homes are priced at values supported by mortgage rates sustainable over the next 5 to 10 years.." certainly supports this.

The price of money isn't the issue - it's the price of goods (homes) that is keeping buyers out. I wrote a bit about this myself last week as related to John Taylor's assailing of the Fed regarding lower interest rates: scottsambucci.blogspot...

2008 Dec 22 08:35 AM

[Leftfield:]

I'm trying to understand why only collateral and low prices matter now to lenders and borrowers. We've spent trillions to aid and comfort lenders and Fannie Mae and Freddie Mac debt has been explicitly assumed by the taxpayers.

After trillions spent in the largest heist in history for bailouts, perpetrators unaccountable, we can't have low rates? Now we're told low rates won't help home prices? C'mon, please give us some crumbs from our own table.

Sure, treasuries are going to rise by the next 5-10 years you say. Mortgages packaged today should mostly reflect today's rates though.

After all this unccountable money thrown at the problems, taxpayers can't have much of anything as usual.

2008 Dec 22 09:23 AM

[scotty1560:]

It's a little bit of everything isn't it? Was much easier for me to buy 7-8
years ago before the brutal real estate tax hikes and insurance hikes and
water/sewage hikes. Everyone talks of prices and/or mortgage rates
but forgets the added 3rd payment of these other factors. And or course
local government does not want to give back with lower taxes-
all part of the ongoing scam. So the owners lose equity/saving in
the home, investors/banks lose via defaults- the local govt and insurance
give back a little tiny portion of the massive hikes. The generals get to
pick and choose the deflation effects. A 500k home in South Florida
equals about 10k in annual real estate taxes, 5k+ in insurance, 10k+
in maintenance, 2k in water/sewage. That's 25k annually or 2k monthly -
tell me what effect that has on ownership or investment? Make little sense
to own anymore, and the tax write off isn't enough to offset the burden.
Taxes and inflation have systematically killed every phase of quality living in this country- the good news is your hard earned money gets to pay for
a baseball/football stadium, ballplayers and team execs are hurting, right?

2008 Dec 22 09:51 AM

[Poor me:]

Greed.

2008 Dec 22 11:42 AM

[Steven Hansen:]

good points. and when the interest rates increase, whatever lender is holding this paper will take a haircut. i would not lend at these rates.

2008 Dec 22 07:01 PM

[WolfLives:]

There still lying crooks- Thats why. Look at the fraud they passed off all this time. Who do they have you praying too?
Amen is represented in five forms:
1. As a man, when he is seen seated on a throne, and holding in one hand the scepter, and in the other the symbol of "life." In this form he is one of the nine deities who compose the company of the gods of Amen-Ra, the other eight being Ament, Nu, Nut, Hehui, Hehet, Kekui, Keket, and Hathor. 2. As a man with the head of a frog, whilst his female counterpart Ament has the head of a uraeus. 3. As a man with the head of a uraeus, whilst his female counterpart has the head of a cat. 4. As an ape. 5. As a lion couching upon a pedestal.

2008 Dec 22 11:08 PM

[Harriet33:]

Very well written article. Thank You!

2008 Dec 23 12:18 AM