Why Can't The Media Tell You When Mortgage Rates Are Falling? It Doesn't Know How Mortgage Rates Work.

Mortgage bond markets are signaling a slight return to risk this morning. If you're watching the wrong market indicators, though, you probably didn't get the memo.

Looking at the chart above, we see that as of 9:02 AM ET:

* Mortgage-backed securities are improved by 28 basis points
* 10-year U.S. treasury notes are off by 106 basis points

This tells us that mortgage markets and treasury markets are moving in opposite directions. It also tell us that mortgage rates are improved today.

The chart counters the popular notion falsehood that 10-year treasuries are a good proxy for the mortgage market. They're not. Long-term, maybe. But on a day-to-day basis -- no way. This is because investors continue to treat the debt types differently even though the government nationalized the mortgage market six weeks ago.

That's kind of a big deal because, in theory, U.S. treasuries notes and mortgage-backed securities should behave the same. In practice, however, they don't.

Investors still place risk premiums on mortgage-backed money and that prevents treasuries yields and mortgage rates from moving in lockstep. The risk premium prevents the theory that 10-year treasuries can be used to predict mortgage rates from ever being true.

Last week offered a terrific, in-the-wild example.

For the first few days of the week, as stock market money headed for the exits, it flowed equally to treasury and mortgage-backed markets. Rates on both types of debt improved.

By the end of the week, however, fear had gripped the markets so tightly that money flowed into treasuries almost exclusively. The assumption was that treasuries were a less risky market.

Mortgage rates got hammered as a result.

If the risk in treasuries was truly equivalent to the risk in mortgage-backed markets, this separation would never have occurred.

So, today, what we're seeing is money is un-parking itself from the relative safety of U.S. treasuries, flowing back into stocks and mortgage markets. This is helping to edge rates lower even as U.S. treasury yields rise.

Why Are Mortgage Rates Decreasing Since the Takeover of Fannie Mae and Freddie Mac?

When comparing two investments with equal risk, a rational person will choose the investment with a higher rate of return.

This behavior is called Risk Aversion and is a basic tenet of personal investing.

An off-shoot of Risk Aversion is that a rational person will only invest in an instrument of greater risk if the returns are greater.

The chart at the right illustrates this concept, comparing rates of return on two investments:
* U.S. Government bonds
* Mortgage-backed bonds

The difference in investment return rates is sometimes called a "spread" and the historical spread between government debt and mortgage debt is somewhere near 1.5 percent.

However, notice how the spread started to grow starting in July 2007.

July 2007 marked the "official" start of the Credit Crunch and as mortgage delinquencies grew nationwide, so did the market's perceived risk of investing in them.

By the start of this month, the spread had nearly doubled.

But that all changed Sunday. When the government announced its takeover of Fannie Mae and Freddie Mac, it put the same "risk-free guarantee" on mortgage debt that has helped keep U.S. government debt so cheap to finance and the spread immediately shrank.

This is one reason why mortgage rates fell Monday and why they should continue to stay low over the near-term. With the U.S. government backing the mortgage market, there's no room for the risk premium that helped keep rates high this past year.

It doesn't mean more people will qualify for conforming home loans, but for the ones that do, financing should be cheaper.

Have a specific mortgage question? Call or email me anytime!

Further Evidence That You Can't Use the 10 Year Treasury Note As An Indicator for Interest Rates

For years, people unfamiliar with the mortgage industry have said that the government's 10-year treasury note is a reasonable reflector of mortgage rate direction.

Unfortunately, this is not the case. The only security that matters to mortgage rates is the price of a mortgage-backed bond.

The chart at right supports this idea. It's shows the interest rate "spread" between the 10-year treasury note and the 10-year Fannie Mae note.

Notice how the spread is widening.

On a technical basis for Wall Street, the widening spread means that debt issued by the conforming mortgage securitizer is considered a riskier investment.

On a personal basis for Main Street, though, the widening spread reflects the modern problems of Fannie Mae which will likely lead to both higher mortgage rates and larger loan fees for you and I.

Watching the 10-year treasury is not an effective way to track mortgage rates. And if it was an effective way in the past, the chart shows us that it's certaintly not any longer.

Why Even "The Gamblers" Are Asking To Lock Mortgage Rates As Early As Possible

If you look at mortgage rates today and compare them to January's numbers, not much has changed:

30-year fixed: Still hovering near 6 percent
7-year ARM: Still lower than 30-year fixed rates
5-year ARM: Still lower than 7-year ARM rates

But on a day-to-day basis, the market is not as smooth as the comparison would have you believe. Mortgage rates are more like The Vortex -- two double-loops, a corkscrew and a batwing.

Enough to make you vomit.

If you've been shopping for a mortgage lately, you know what I mean (alternate link) and unless you're getting my Twitter updates piped to your mobile, you're left looking for clues anywhere you can find them.

For example, although mortgage rates were the mirror-opposite of the stock market Thursday and Friday, there's no long-term relationship between the two upon which we can draw. We can't say "when stocks are up, rates are down", or vice versa, because there are many days that the two move in tandem.

The biggest clue we have about mortgage rates is that they respond to expectations about the economy. Because of that, we should expect the loop-de-loops to continue until 1 of 3 things become clear:

It's proved that the U.S. economy is in a recession
It's proved that the U.S. economy is experiencing inflation
It's proved that the U.S. economy is experiencing both recession and inflation at the same time

Unfortunately, recognizing recession and inflation is a lot easier in hindsight; the same way we look back at a bubble. While you're in it, it's too hard to tell what's happening.

For example, just when the experts think our economy is growing gang-busters, we get hit with record unemployment data and talk of panic.

So much for the experts.

Mortgage rates are getting whipped the ongoing Recession vs Inflation debate, so if you're not the type to gamble with your household budget, consider locking your rate right away. What you're really doing is locking in a worst-case mortgage rate scenario.

Shoot, even if you do like to gamble, think about locking in. Even though mortgage rates may fall, they may not fall during the time period that you need them to.

In other words, rates may not fall until after your closing.

Instead of waiting for the big drop, take some chips off the table by locking in now. If rates fall after your closing, you can always remortgage down to the lower rate. And by then, maybe we'll know if this was a recession or just a blip on the radar.