“Federal Reserve officials are focused on driving down the spreads between U.S. Treasury yields and consumer and corporate loans, after cutting the main interest rate to almost zero failed to revive lending.
Credit costs for households and businesses haven’t followed yields on government debt lower. Fifteen-year fixed-rate mortgages were at 5.06 percent last week, 2.59 percentage points above 10-year Treasury yields; the spread averaged 0.88 point in 2003, when the Fed slashed rates to 1 percent.”
∙ Fed Focuses on Consumer, Corporate Rate Spreads Over Treasuries [Bloomberg]
If mortgage risk premiums in 2003 were 0.88%, history has shown they were far too low. Risk premiums are intended to absorb defaults, and still return profits. Obviously, this didn’t happen.
And with real estate prices still falling, and the economy tanking, one must wonder whether a 2.59% risk premium is sufficient now. Maybe it’s enough if you factor in a 20-30% down payment and scrupulous income verification.
It’s hard to compare 0.88% and 2.59% on an apples-to-apples basis, because it’s unclear what the average down payment was in 2003 vs. today, plus real estate assets are depreciating, not appreciating.
So as an investor, I’d pass on a mortgage backed security with a baked in risk premium of 2.59%. The only likely buyer here is the US government, with taxpayers subsidizing losses.
dd,
“The only likely buyer here is the US government, with taxpayers subsidizing losses.”
don’t forget that some ‘friend of hank’ bank will buy them first and make plenty-unless they do not, in which case these mbs will be dumped on the taxpayer forthwith…
Getting specific about risk premium numbers does not necessarily make sense. The system broke down such that assessments and loans were all based on made up and fraudulent numbers, so insuring all that became a more complex problem than could be apparent on the surface. Now that the bubble is deflating the main problem is to coax prices back down out of the stratosphere.
2.6% risk premium. Let’s see, if 5.2% are foreclosed on, and the recovery is 50%, then it’s breakeven vs. treasurys for the lender. Considering you’re talking about new loan originations, that’s a decent bet, as they all require at least 20% down and documentation etc.
I just refi’d and locked in 4 7/8% on my conforming East Bay loan (22% LTV). no points. Thanks Helicopter Ben! My P&I is now lower than my rent was in 2005 for a house that was literally half the size.
I posted a comment here previously, which seems to have disappeared. But I’m curious what the crowd thinks (especially LMRiM) regarding all the recent talk of a treasury bubble. Lots of folks think the flight to quality will end soon, investors will dump treasuries, and rates have to rise to keep our creditors interested. This coincides with our new administration’s plan to borrow $2 trillion to stimulate us with. Do you think we see a meaningful jump across the term structure this year?
Regarding spreads, seems foolish to try to compress spreads when credit quality is declining (i.e. defaults are still increasing, across all classes of debt). Analogous to trying to sell a burned house…while it’s still on fire.
There would seem to be a market opportunity here for a home-lending enterprise to offer lower rates, provided (1) that the home buyer makes a substantial down payment (20%+), and, crucially, (2) that the value securing the loan is established using the income method (normalized rent multplied by a historically justified multiplier), rather than comparable sales.
I wonder what it is about the industrial organization of the home-lending business that prevents this from occurring.
I believe that there is a bubble in Treasuries, as a run up to 4 or 5 per cent will lower their values. I also think that mortgage loans should be packaged in securities based on their level of risk. A pool of loans with a 50% LTV & a 780 FICO should have a much better risk spread that loans with 95% LTV or with FICO’s of 680. Quit having low risk borrowers and low risk loans subsidizing high risk borrowers with little risk in the property.