Mortgage rates are still too high

Given all the risk in the real estate market, how can someone make a case for rates being too high? The lender needs to be compensated for the risk. Probably if prices drop and then there is less risk, rates could be lower.

If you were a bank, would you want to make a jumbo loan in Manhattan with a 20% downpayment?

Not me. But if I did, I'd demand a big fat spread to reflect the risk.

Read the article. These rates are for conforming mortgages, which are guaranteed by Fannie or Freddie, and therefore they are guaranteed by the government. That is why the Fed is buying agency paper, but it's still not enough.

Markets are not working right now.

The only thing stopping this market from "working" is seller denial. This market will clearly work, and work well at a proper price point. There is nothing stopping equilibrium from being established except sellers hopes. This too, will pass.

I'm with patient09.

At the proper price point markets will start to work again.

That includes the "spread" market. One man's spread "cost" is another man's spread "income." Savers have been screwed for too long. Now they're being nicely rewarded. BTW, MBS spreads are not only related to credit risk (which you may think of as negligible) but also prepayment risk and interest rate risk.

I was discussing the mortgage market not working.

But agreed - the seller-side isn't too rational, either.

At the proper price point "mortgage markets" will start working too. We're just seeing a cyclical shift in power between the borrowers and the lenders. At the proper price point savers will shift their money from "safe" money market investments to "riskier" bonds.

Money market rates have tumbled to ~2% while spread product continues to offer nice current yields. I'm of the view that we are just starting to see investors consider ~7% yields now on investment grade bonds. Same goes for MBS bonds.

That's capitalism. A messy system - but a self-correcting one also.

Think mortgage rates are too high? Then buy a mortgage fund. Think investment grade credit spreads are too high? Then buy an investment grade fund. Right now investors have record money market fund assets as a percent of their total investment assets. Only way to entice them out of that "ostensible" safety is nice spreads to (expensive) Treasury bonds. Seems to me that long Treasury bonds are the bubble du jour. In order for me to play in the spread bond arena I require nice spreads.

"At the proper price point "mortgage markets" will start working too."

Please explain. The proper price point for what?

"I'm of the view that we are just starting to see investors consider ~7% yields now on investment grade bonds. Same goes for MBS bonds."

Topper, the reason for this lies in PHASE II of the feds strategy to fix this mess; that has been months in the works. PHASE I was to capitalize (think first tranche of TARP), PHASE II is set the entire system up to encourage private investment in riskier products by bringing treasuries way way way down (think 0% FFR and quantitative easing), so that the yield is so low that you consider alternatives. Not the little guy, the big boys Im talking about here.

PHASE III will likely be to rid the balance sheet of toxic assets, transfer it to either TARP 2 or RTC like vehicle.

Makes sense when you put yourself into the feds shoes.

urbandigs,

BTW, I enjoyed your yearend outlook - particularly as regards Manhattan real estate. Thanks.

As regards, PHASE II, I agree. As an fyi, a fair number of institutional investment consultants are hopping on the bandwagon pushing long term investment grade bonds as an "equity alternative." Long duration credit spreads have been particularly painful on the way down but could be particularly delightful on the way up - especially for pension funds with long term liabilities marked to the AA yield curve. Yes, the little guys may be a bit slower on the uptick, but I am hearing increasing rumbles about the miserable ~2% yields out there. Still abject fear - but early rumblings of the slightest of appetite for low risk securities.

Steve,

To me the proper price point on MBS refers to their spreads over Treasures. Tight spreads (to Treasuries) don't interest me. Wide spreads do. As in the equity real estate market there has been a bit of a buyers' strike. But buyers are reappearing at these new levels. I expect bid-offer spreads will gradually tighten again at these spreads to Treasuries. BTW, the MBS market is already far more liquid than that of investment grade bonds, munis, and particularly high yield and bank loans.

"Wide spreads do."

But they're not natural, which is the point of the article.

Mortgage market continues to work fine. Problem is the mind set of many think 2001-2007 bad financing is normal. I hope, that we never return to those financing terms. I purchased my first investment property in 1986, terms were similar to now. Additionally, rates were double digit. 20% down, good credit score, proof of rentability (if that is a word). No complaints. Toppers got it right, if you don't like the left, then go right. It is a 2 sided market. In Sept, Oct and Nov I started dipping the toes in a few. HYG, LQD, MUB and TIP. This is more of a "speed" play than anything else. If you think corps, both high grade and high yield, munis and inflation yields and expectations are too high, then buy the credit. When they tighten, take out a mortgage and you have got paid in the interim on the tightening.
If you are wrong and spreads widen further, RE will be down in colossal proportions, then you buy cheaper, and take a hit on the ETF's

Ah, but what is "natural?"

Spreads vary over time - and often suit the times. Tuesday's OAS (optioned-adjusted) MBS spreads was 1.65% versus an 11-year average of 0.65%. Note that the standard deviation of the spreads was 1.08% - so we're talking about a one standard deviation event. Big deal.

Investment grade spreads, by contrast, were selling at an OAS of 5.69% versus an average over the same period of 1.37%. Standard deviation: 2.90%.

I see more risk-adjusted value with investment grade bonds - but they are clearly riskier.

The key thing to remember is that MBS need to compete with all other alternative investments.

Not "natural?"

Hey, markets fluctuate. Sometimes there is more low hanging fruit than other times. But it takes some courage to reach for them. As a rule, I generally try to only make bets when different investments are in the top 20th percentile of valuation levels. Most bond spreads are now in about the 5th percentile of their historic valuation levels.

As a renter, I say, "yea!" As Honore de Balzac said, "Make the money sweat!" That's exactly what it is now doing.

I'd like to buy Manhattan real estate too. But I see its valuation levels to now be in the 95th percentile and thus quite dangerous.

One can look at PE ratios the same way. That said, I do prefer the Shiller's 10-year real PE calculation to simply trailing PEs. In October, 2007 we were at the 85th percentile based upon history going back to 1926. At the end of November, 2008 we were in the 44th percentile - modestly below long term averages.

"what is "natural?"

The historic average, which over time has been fairly constant (low standard deviation). Once again it's one of the unintended consequences of the Lehman bankruptcy - look at the day the chart goes haywire.

"MBS need to compete with all other alternative investments."

But they have an implicit government guaranty, so they should trade at about the same as treasuries.

There is a bubble in these "risk-free" investments right now. I'd be concerned.

"I'd like to buy Manhattan real estate too. But I see its valuation levels to now be in the 95th percentile and thus quite dangerous."

I couldn't agree more. There's another 40% to fall in my estimation.

OK. I guess your "natural" is my "average." Let me just add that valuation metric distributions are not particularly "normal" in shape and they tend to have fat tails.

Yes, MBS do have an implicit government guaranty. But unlike most government bonds they have pre-payment risk. So, if MBS interest rates were to fall from what you consider to be lofty current levels, people will refinance and you're then stuck with cash when interest rates are low. They also have wider bid-asked spreads than Treasuries. And finally, Treasuries are not subject to either NY State or NY City income tax. Bottom line: I require a higher interest rate on MBS than on Treasuries.

Long term Treasuries are, indeed, RISKY. The long bond had a return of almost 40% in October/November/December. Nice bubble! We agree.

I think you are right on as regards NY residential real estate. You have long been a beacon of sanity as regards that subject. We're in for a bumpy ride!