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Interest rate fact of the day
As of yesterday, lenders were charging an average of 7.34 percent for prime, 30-year, fixed-rate jumbo loans, according to financial publisher HSH Associates. That was up from an average of 7.09 percent last week.
It was also 0.75 percentage points more than the 6.59 percent they were charging for conforming loans. In mid-July, the difference between the two types of loans was 0.20 percentage points.
If you think this is only a liquidity event, there is of course a profit opportunity. Note that the 10-year T-Bond rate has been falling. I am more inclined to think we are returning to a more reasonable spread between mortgages and Treasuries; let's hope the transition is a relatively smooth one. If trading volume is low, traders may fear the other trader knows something he doesn't ("no-trade" theorems are one source of Robin Hanson's theorems on disagreement between persons), and we're not yet in a new regime where such concerns are shrugged off or attributed to mere churning. Since regular trading is part of what brings expectations to such a new regime, the adjustment doesn't generally occur right away (even when prices are flexible) and the ride can be a rocky one indeed.
Here is the cited article.
Posted by Tyler Cowen on August 10, 2007 at 07:33 AM in Economics | Permalink
Comments
These things are rarely smooth.
Posted by: glenn at Aug 10, 2007 8:47:43 AM
Your analysis addresses only the spread between
Treasuries and mortgages--implicitly, the price of risk.
However, the quotation also reports on the spread
between conforming and jumbo mortgages (roughly, those
below and above $400,000). That spread probably does
not depend on risk--most mortgages on both sides of
the divide are prime--but the fact that Fannie and
Freddie can buy mortgages below the divide but not
above. So the existence of the gap presumably reflects
our odd regulation of the market, and the widening of
the gap presumably reflects changes in liquidity. How
long it takes enough people with deep pockets to seize
the profit opportunity is a critical question.
Posted by: Doug at Aug 10, 2007 9:02:48 AM
Removing arbs this size requires the patient application of $billions at high leverage. Anyone
in that business has been clubbed like a baby seal for the past two months, to the point the ECB
and Fed have had to keep the banking system afloat for the past two days as the money markets
failed to clear. We'll get to sorting these dislocations out once we figure out who's left to do
it. Right now, anyone trying to fix someone else's liquidity/solvency problem is just taking it on for
themselves.
Posted by: mkl at Aug 10, 2007 9:52:41 AM
thanks...
Posted by: ivan at Aug 10, 2007 11:06:42 AM
I dont think this is just a liquidity event. I think we are looking at a credit event that is causing the liquidity crisis, where entities can't pay what they owe.
We are in a regime change situation, the black swan if you will, where what was normal just a few days ago is considered to be based on flawed logic.
My Prediction: this is going to cost the U.S. taxpayer trillions. Probably like $2-3T, with a high of 4.5T. It will be sold as a bailout of homeowners, but somehow most of the benefits will go to investment banks and their investors. Individual homeowners will still be left with the bankruptcys and foreclosures, but the owners of the debts will be made far more whole then they would by just selling their now worth much less assets in the open market.
The fed is injecting liquidity again as we speak, an unprecidented move. As the home price bubble bursts - it is as I write these words - there is nobody short these assets. They are not futures markets. This is wealth that is being destroyed, just nobody knows it yet.
Posted by: mickslam at Aug 10, 2007 12:07:41 PM
mickslam, do you even know what you wrote above?
prof cowen, refusal to trade need not be because only of information, it might be because of different assumptions, although the two are broadly the same.
Posted by: sa at Aug 10, 2007 1:15:36 PM
lol.
Posted by: mickslam at Aug 10, 2007 2:46:43 PM
Doug, your analysis is pretty good, but the widened spread between conforming and jumbo loan rates does derive, in large part, from perceived risk.
You'll note that mortgage-backed paper issued by FNMA or FHLMC isn't suffering a liquidity or risk issue; the value of their paper is a knowable quantity due to rigid underwriting standards. That market is chugging along nicely.
However, the paper backed by certain non-conforming loans (mostly subprime, though concerns have spread to some alt-A) which is _perceived_ as not having been made to the same rigid standards -- and/or which is _perceived_ as not having been as thoroughly vetted by the ratings agencies -- is the paper that can't presently be valued simply because it aren't saleable right now without a premium to a buyer. Suddenly, the assurances of yesterday aren't so reassuring today. Anything not-Fannie/not-Freddie is suddenly suspect, and irrational non-exuberance is the norm.
The mess will sort out when sane valuation returns to the market. How that will work is what to watch. And, you're right that there will be profit opportunities -- for some.
Posted by: Paul Havemann at Aug 10, 2007 3:06:57 PM
I know my mind is in the gutter. But this struck me as hilarious when listening to NPR news today.
Reporting on the three liquidity injections we saw today, the news-reader coldly stated, "The Fed went into ATM mode today."
Classic. Too bad I cannot record such things.
Posted by: Richard Pointer at Aug 10, 2007 7:07:39 PM
Richard Pointer. But you can record such things. NPR posts all its news shows as podcasts. Just download it and then you have it saved.
Mickslam: Why do you think the fed pumping liquidity into the system is unprecedented? It was done in 1987 and many other times. Some theorists believe that had the Fed or its equivalent done so in 1929, the Depression would not have been as bad.
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