TEAM EMPOWERMENT MORTGAGE CHATTER: May 19, 2009: California becoming more affordable; a lesson on the yield curve & mortgage spreads…Kiplinger CA letter and Forecasts

“Those whom we support hold us up in life.”

~Marie Von Ebner-Eschenbach


What is the yield curve, and why should anyone care about it? Yes, the stock market is rallying, in part because some corporate earnings are not as bad as expected, but also because many feel that the stock market “looks ahead” into future business patterns. This is good for anyone with money left in their 401(k) stock plans, but most economists put more weight on the fixed income market’s view of the economy. And specifically changes in the steepness of the Treasury yield curve – one of the best and most consistent leading economic indicators of the economy. The curve itself charts the yields of Treasury debt versus the maturity. So short term debt, like 3 months, has a certain yield which is typically lower than that of 30-yr bonds.

But how much less? Over the past month, we have seen a rapid steepening of the Treasury yield curve, which suggests the probability of economic recovery in the second half of 2009 is quite high. But in addition to Treasury rates, one can also plot the spread of other instruments like corporate bonds or mortgage rates for a comparison, which results in a spread between the two. Corporate bond spreads, for example, have dropped significantly in the last 30 days since the demand for them has increased by investors, and corporations are taking advantage of the drop in yield spreads to sell more debt. It’s cheaper for them.

What about mortgage spreads? As everyone knows, the Fed has been buying agency mortgage-backed securities (so far they’ve bought about $370 billion), and this has dropped 30-year mortgage spreads over 10-yr Treasuries back to their historical averages. Historically, the spread between the 10-year note and 30-year fixed rate mortgages is typically about 1.25%-1.5%. In 2006 it averaged 150 basis points, in 2007, the average spread was 156 basis points, but in 2008 the average spread was 216 basis points. In January of this year the difference was 2.21%! Now the spread between a 10-yr Treasury note and a 30-yr mortgage is back down to 1.55%, which is obviously good news for mortgage originators.

California, like all states, is seeing the percentage of households that can afford to buy an entry-level home increase. According to the California Association of Realtors, the number stood at 69% in the first quarter of 2009, compared with 46% for the same period a year ago. Assuming 10% down and an average entry-level price of $213,040, the income needed was $38,090 (based on an adjustable interest rate of 4.96%). Last year a borrower needed about $65,000 of income to qualify, so this is a drop of 41%. According to CAR, the median household income in California is $61,030.

The only news out today was Housing Starts and Building Permits, which unexpectedly fell to record lows in April. The Commerce Department said starts fell almost 13% to an annual rate of 458,000 units, the lowest on records dating back to January 1959. Heck, that was before I was born! New building permits, which give a sense of future home construction, dropped about 3%, the lowest since records started in January 1960. Both numbers are significantly lower than a year ago. The news this morning has served to put a damper on the stock market (“So much for that housing pick-up!), and the 10-yr yield stands at 3.24%. Mortgage prices, which, along with bonds, worsened yesterday with the rally in stocks, are roughly unchanged from Monday afternoon.

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