Mortgage meltdown?

The mortgage market is going through a significant upheaval with spreads widening to levels that we have not seen since the mid 1980's. Since the beginning of the year we have seen spreads move from 160 bps to the current level of 225 bps for current coupon 30-year GNMA 8% coupon and from 170 bps to 240 bps for 30-year FNMA 8% coupon. A year ago we were looking at spreads in the 100-120 bps. What is surprising about these spread changes is that GNMA has the full faith and credit of the US government and FNMA is a government sponsored entity GSE.

Ar these a good deal? Hard to say because the underlying collateral may be changing and it is not clear what the impact would be on the pool if there are increases in delinquencies and foreclosures. We are in uncharted territory, but what was previously a low risk instrument is now priced as a risky security.

This widening of spreads starts to change the calculus of investing for foreign capital. In the near term, the higher risk has pushed capital back to home countries which have currency account surpluses, but over time these spreads will look attractive and will offset some of the decline in Treasury yields. Using interest differentials for government bonds may send false signals on what may happen to global capital flows.