MBS vs. Treasuries Debate Cont.

Is the rise in Treasury rates causing a concomitant rise in mortgage rates? There could be another explanation. From the WSJ:

The number of potential home buyers who signed contracts to purchase existing homes jumped by its largest margin in eight years and rose for the third straight month in April.

The current rise in mortgage rates might be due to increased demand for mortgages. Does this mean we've hit a bottom in real estate prices?! No, this information isn't conclusive on its own.

As for NYC, I think it's still in store for a deeper correction if you refer to this older post.

An Explanation of the MBS vs. Treasuries Debate

Federal Reserve efforts are stalling as a lack of demand for 10 year treasuries is causing yields to rise on new mortgages. From Bloomberg:

Federal Reserve Chairman Ben S Bernanke's efforts to bring down borrowing costs to revive the housing market and help the economy are stalling. Mortgage rates are almost back to where they were in March before the 30-year rate fell to a record and sparked a refinancing boom.

For those who don’t know, the process works like this. One must first make the distinction that there is a primary and secondary market for mortgages. The primary market for mortgage origination takes its cues from the secondary market for mortgage backed securities (MBS).

The central bank purchases MBS guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae which causes prices to rise and yields of those securities to fall. A robust secondary market sends the cue to mortgage originators to reduce the rates on new home loans (they can make more loans at lower rates). GSAs-- comforted by the fact that the Federal Reserve is propping up the market-- will buy loans from originators to pool, securitize, and sell at a profit.

If the secondary market softens, then rates must invariably rise. This is currently occurring as investors opt out of MBS and Treasuries in anticipation of higher market interest rates going forward.

But, mortgage rates aren’t necessarily tied to those of Treasuries as reports would have us believe:

Yields on Fannie Mae and Freddie Mac mortgage bonds rose earlier this week, driven higher in part by climbing Treasury rates. The yield on the 10-year Treasury note was at 3.64 percent yesterday, compared with 3 percent the day before the Fed’s March 18 announcement [Bloomberg].

Although MBS track treasuries they can and do move in the opposite direction. Since there is no loan that uses the 10yr or 30yr as an index there is no iron-clad correlation. Theoretically, it would be possible for the spread between treasuries and mortgage rates to tighten if the Fed picks up its purchases of MBS.

The NY Real Estate Bubble is Still a Bubble

If this graph of NY Condo prices had been rendered from 1900 it would show that the growth in prices since the turn of the century would pale in comparison to the exponential growth displayed by this market over the last 10 years.

This growth has eclipsed most other asset classes. To put in perspective, consider that NY condo prices have ballooned 107% compared to the S&P 500 and DJIA which have been more volatile and declined 45.6% and 30% respectively since Jan 2000.

The perception that deals abound in the condo market is suspect by historical standards. The NY residential real estate market has been astoundingly resilient despite the most catastrophic economic crisis to hit Wall Street since the Great Depression. Case-Shiller condos are only 11% off their highs vs. the S&P and DJIA which are 45% and 48% off their respective highs.

It is very possible that the real estate market is experiencing a permanent re-pricing which would preclude a reversion to the mean. With tighter underwriting standards, rising mortgage rates, and more modest consumer habits thanks to economic uncertainty, it would be difficult to experience a repeat of 2003-2007 in the short to medium term.

A case could be made for stagnation in the long term as well, as long term residential real estate prices are tied to wages. What makes the NY real estate market a curious one is its current resilience in the face of disproportionate wage cuts and job losses vs ROW. If it’s safe to assume that the NY real estate bubble was created by an explosion in wall street wages and loose lending standards [with time I can perform an econometric study regressing the effect on real estate prices through wages and residential lending] then a permanent decrease in wages-- both in individuals employed and wage/individual--due to a suffering banking system and sustained populist outcry against excessive bonuses for wall street bankers coupled with tighter lending standards should lead to a permanent decrease in prices for this market.

NY: Case Shiller Need Not Apply

March data from Case-Shiller was recently published and its results were extensively covered in the media. NY Metro followers of the Case-Shiller index should note that “to be eligible to be included in the home price indices, a house must be a single-family dwelling. Condominiums and co-ops are specifically excluded.”

Since x% of Manhattan is condominium, it’s more helpful to look at the lesser-known Case-Shiller condominium index for New York. The performance of this index isn’t much different from its more popular counterpart (NY Condo prices have fallen 10.0% YoY as of March 2009 vs. -12% for the plain vanilla Case-Shiller index) but it does highlight a more explosive real estate rally since January 2000 (prices are up nearly 107% since January 2000 vs. 73.4% for vanilla Case-Shiller).

Data for the Case-Shiller condo index can be found here.