More on Mortgage Rates

A few weeks ago, I wrote that mortage rates are likely to improve. That was based on 1) the Treasury's proposal to push mortgage rates down to 4.5%; and 2) the fact that the spread between 30-year mortgages and 10-year Treasury's was at 2.8 percentage points, which is nearly double its long-term average.

Paul Krugman weighed in today on the subject in his New York Times blog, arguing that since Fannie Mae and Freddie Mac (i.e., the dominant mortgage lenders in today's market) have effectively been nationalized, there is little reason for investors to shun their debt in favor of Treasury bonds. In other words, Fannie and Freddie should already be able to write new loans at a spread that's comparable to historical levels.

The historical average spread between 30-year mortgages and 10-year Treasury's is roughly 1.6 percentage points. Adding that to the current 2.15% yield on 10-year Treasury's, you get a 'normalized' mortgage rate of 3.75%. For comparison purposes, mortgages are currently being written at around 5.15%, which is already the lowest since the Fed started doing its rate survey in 1971.