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Friday, January 06, 2006

Calculated Risk: Mortgage Spread

Here's an interesting fact for the next time you teach about interest rates: the spread between interest rates on 30-year mortgages and ten-year Tressuries has increased by almost 50 basis points (a half percent) over the last year.

So, what caused the change?

It's probably not due to changes in the yield curve, since the duration of 30-year mortgages is somewhere around 10 years, or even a bit less (mortgages tend to get paid off or refinanced well before their term).

What's more likely (as hypothesized by Calculated Risk) is that it's driven by investor perceptions of risk in the mortgage-backed securities (MBS) market. Today, most mortgages are "securitized" (packaged into portfolios that are used to back securities issued on the cash flows of the portfolio). So, if MBS investors view them as riskier, prices drop, and rates on these securities rise. Of course, this feeds back to the mortgage market, which could partially explain the rate increase.


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