Wednesday, March 5, 2008

Expect interest rates to keep moving higher

There was a great piece on CNBC this morning on the trading in the mortgage markets. Traders bluntly said they had never seen anything like the trading that went on in yesterdays mortgage market. The spread between the 10 year treasuries and the 30 year mortgage rate widened to 200 basis points which is the largest spread EVER seen between the 10 year treasury and the mortgage rates on a 30 year. The average historical spread here is 120 basis points.

What does this mean to you? Higher mortgage rates going forward. Fear has reached an unprecedented level in these markets and banks are finding no buyers in the secondary market to buy the mortgages after they approve a mortgage from a home buyer. Because of this fear banks are lending at higher rates. Right now the 10 year treasury is at 3.5%. Mortgage rates are anywhere from 5.5%-5.9%. So if the banks were to use the average hostorical spread of 120 basis points rates should be around a shade under 4.9% with great credit. They refuse to use these historical spreads because they can't sell the mortgage.

Until the credit markets come back and start buying mortgage bonds from the banks and brokers then you can expect higher mortgage rates. Right now NO ONE is buying any mortgage related products because they are afraid if they buy at $80 this week that it might only be worth $70 next week. These are historic events in the mortgage market and shows you how bad things are.

A great example in the video below. there are some secondary bonds that are available to be bought that are very safe from a default perspective and offer an 8% return. A bank could borrow at 3%(Fed Funds Rate) and buy this safe bond at an 8% return for a profit apread of 5%. Sounds like a no brainer right? The problem is there is such a fear that these bonds will be worth less tomorrow or next week that the 5% spread doesn't look so appealing because you could potentially lose money if the bond drops in value.

My take on all of this for you home buyers out there is to wait this out before buying. Spreads will eventually return to normal and rates should come back down a bit. However, if the Wall St. continues to be unwilling to buy these mortgages from the banks then expect things to get worse and rates could go much higher. Something has to give here and if this problem persists then expect a blowup at some point in the near future.

Overall things are unravelling in the mortgage market and you need to stay away until a solution is found and the mortgage market stabilizes. This may take a FED bailout where they start buying the mortgages. This may be the only answer but its not a good one for the housing market. More on this later.

You can check out this CNBC video to learn more. The time bomb keeps ticking.

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