Residential mortgage bonds, the center of the financial crisis not long ago, are once again darlings of the financial market.
Investors are seeking out mortgage bonds backed by the U.S. government as a safe haven from the tumult of the global economy, a reversal of fortune that has helped drive mortgage rates for consumers to record lows.
Thursday saw a slew of downbeat data, with the Institute for Supply Management saying its index of manufacturing activity fell unexpectedly to its lowest level of the year; auto makers reporting lower U.S. sales in June; and the Labor Department announcing a rise in weekly claims for jobless benefits.
The average rate for a 30-year fixed-rate mortgage tumbled this week to 4.58%, government-sponsored mortgage agency Freddie Mac said Thursday, from 4.69% last week. That is the lowest rate since Freddie Mac started keeping track in 1971.
Typically that would be good news for the economy and the beleaguered housing market. Falling mortgage rates often act as shock absorbers for a troubled economy, triggering waves of mortgage refinancing that put cash in homeowners’ hands by lowering their monthly payments.
But relatively few homeowners have so far taken advantage of the low rates to refinance, in part because a large swath of eligible homeowners refinanced when rates were almost this low last year, while those remaining lack some of the qualifications needed.
A refinancing wave would be welcome now, with the economy appearing to lose momentum. The housing market has been a particular source of worry. A report Thursday from the National Association of Realtors showed that pending home sales sank 30% in May from the month before, far worse than economists expected.
Those data came ahead of the June jobs report, due Friday morning, which the market hopes will show an improvement in private-sector hiring.
Once toxic, mortgage bonds have benefited as investors seek safe assets amid the European debt crisis and fears of slower global growth.
The implied government backing of mortgage debt issued by government-sponsored entities such as Freddie Mac and Fannie Mae seems to offer a risk-free investment at a slightly higher yield than comparable Treasury debt.
“For better or worse, right or wrong, most accounts these days see Fannie and Freddie mortgage-backed securities as quasi-governmental instruments, guaranteed even more than in the past,” said Walter Schmidt, mortgage strategist at FTN Financial.
As a result, mortgage-bond prices are near record highs set nearly 20 years ago, according to the Barclays Capital MBS Index tracking the price of mortgage-backed securities.
Bond yields, which move in the opposite direction of prices, are near record lows relative to Treasury yields, even as Treasury yields have also fallen. The 10-year note yielded 2.93% Thursday, the lowest since April 2009.
But so far, refinancing activity has been relatively quiet. Refinancing applications rose 13% last week, according to the Mortgage Bankers Association, but applications are still half their level of a year ago. In contrast, refinancing activity roughly quadrupled when mortgage rates dropped below 5% in 2003.
Borrowers who are still paying relatively high mortgage rates are often discouraged from refinancing by an array of factors, including poor credit scores, low or non-existent home equity or tighter lending standards.
Many of the most eligible borrowers have already refinanced and will need a further decline in rates to do so again. Big banks aren’t always offering customers the lowest possible mortgage rate, suggests Tom Lawler, an independent housing economist in Leesburg, Va.
Jeffrey Solsby of Alexandria, Va., and his wife bought a house in the Beverley Hills neighborhood in August 2006, with a 10-year, interest-only, adjustable-rate mortgage at 6.5%. They also have a second mortgage on the house.
As mortgage rates have tumbled in recent months, the Solsbys have talked to their bank and to mortgage brokers several times about refinancing their first mortgage. Though the Solsbys say they have impeccable credit, with no other debt aside from their mortgages, they have repeatedly been turned down for refinancing. For one thing, their first mortgage was too big to be purchased by Fannie or Freddie, so is not eligible for government programs.
They are also stymied by uncertainty about the home values in their neighborhood, with comparable sales “all over the map,” says Mr. Solsby, who works in public affairs.
Rough estimates of their home’s value suggest they won’t be able to refinance without bringing tens of thousands of dollars more to closing.
He compared his situation to “being on a luxury liner, but being stuck in steerage, watching everybody else have a great time.”
There is a chance that a refinancing boomlet could emerge if mortgage rates fall to 4.5% and stay there for some time, analysts say. At that rate, refinancing becomes economical for a large group of homeowners.
Approximately $842 billion in outstanding mortgage debt, or 16% of the $5.4 trillion market for government-guaranteed mortgage-backed securities, carry interest rates of between 4.8% and 5.1%, according to Kevin Cavin, mortgage-rate strategist at Sterne Agee in Chicago, and would have an incentive to refinance at 4.5%.
The potential for a refinancing boom means that lower rates carry the seeds of their own demise. Investors will start to hedge against the possibility that the mortgages they own will be paid off early through refinancing.
Typically, mortgage yields rise to compensate lenders for that risk. Investors are already starting to wonder if the robust returns they have enjoyed in mortgages can be repeated. If not, then mortgage rates may be slower to fall.
Mortgage returns are up roughly 18% in the past two years, according to Barclays , a rather surprising result given the pain in the housing market.
“The excess mortgage returns of late 2008 and early 2009 were more toothsome than what you would get now,” Richard Cookson, global chief investment officer at Citigroup Inc.’s Citi Private Bank, said of mortgage-backed securities. “If you’re looking for excess returns, there may be other places to look.”
By MARK GONGLOFF
Tags: consumers, Fannie Mae, financial crisis, financial market, Freddie Mac, global economic, home sales, homeowners, housing market, investors, mortgage rates, mortgages
