Krugman: Mortgage Rates Still About 1% Too High

The average zero-points loan up to $417k is about 5.25% and the average zero-points loan up to $625k is about 5.75%. Phenomenal record low rates. But economist Paul Krugman thinks they could be lower, citing that the spread between 30yr rates and 10yr Treasuries is still about double the 150 basis point historical spread. He doesn’t mention anything about the Fed plan to buy about $500b in mortgage bonds, which conforming mortgages (up to $626k are tied to). That plan would drive mortgage bond yields (and thus rates) down further—which, in turn would bring the 30yr mortgage-10yr Treasury spread in line. Here are Krugman’s comments:

Mortgage rates have dropped a lot in recent weeks, which is a good thing. But there’s still a huge spread between mortgage rates and rates on federal debt. Here’s the spread between conventional 30-year mortgages and 10-year Treasuries (10-year because most mortgages get paid off early, when houses are sold, and the average duration is about 10 years.) This spread was historically stable at about 150 basis points, but has been nearly double that lately.

The spread isn’t dead

Why is the spread so high? Presumably because investors are still seeking the safety of government bonds. But what’s bizarre is that these days the government is the dominant mortgage lender, in the form of Fannie and Freddie, which have been nationalized for all practical purposes.

The persistence of the spread offers one opportunity for quick economic stimulus: declare that Fannie and Freddie are backed by full faith and credit, and if that doesn’t work, have the Treasury borrow on their behalf. This can bring mortgage rates down by more than 100 basis points. By itself, that’s not nearly enough to turn the economy around, but it could really help the economic recovery package.