The Mortgage-Treasury Spread remained near its highest ever level in December, as investors retreaed into the safest available investments to close 2008.  Treasury instruments of all maturities saw one of the biggest demand spikes in their history, a sign that risk tolerance was negligible this month.  Throughout the month of December, the spread remained largely unchanged from its December 4th level, closing the year at 2.86%.  This is down slightly from the December 4th spread at 2.96%  The historic low treasury yields reached in December are instrumental to the high spread, as mortgage rates dropped through the month to historically low levels. 

The 10-week moving average spread soared to 2.79% from 2.58%. 

The Mortgage-Treasury Spread measures the relative risk between mortgage securities and comparable treasury securities.  Prior to July 2007, it had enjoyed an extended period of stability slightly above 1.5%, but troubles in the mortgage market have caused it to increase dramatically since then.  Oddly, while negative news about mortgages and mortgage lenders began to slow in the latter part of 2008, increases to the spread did not.

Significant news this month includes Treasury Secretary Paulson's denial of a Treasury plan to pursue a 4.5% interest rate for fixed mortgages, a significant setback to many who thought mortgage rates could easily fall further.  In its discussion of an unprecedented rate action December 16th, the Federal Reserve Open Market Committee annouced it would begin active participation in mortgage markets, including purchase of mortgage-backed securities beginning in January.  Its announcement of this purchase led to tightening of the Mortgage-Treasury spread in mid December, and the result is likely to be further improvement in the spread later this winter as the Fed's demand for these securities replaces demand that is missing from other sectors.

Recent employment data was also encouraging, as fewer than expected applied for first time unemployment benefits.  This reduction may be related to the timing of layoffs around the holidays, however if it forms a trend it could be beneficial.  

Mortgage rates are at their lowest levels ever, yet mortgage availability is still significantly limited due to reductions in home market values and the increase in credit requirements.  Many homeowners applying for refinances at historically low rates are being turned away due to limited equity or due to credit worries.  The mortgage market will remain slow as long as Wall Street investors prefer security to higher returns as has been the case the past few weeks.  One possible bright spot: as of this writing, the Dow Jones Industrial Average is approaching 9000 on the back of 3 straight days of increases, suggesting investors are aware better yields are available.

Dan Hartman is a Senior Mortgage Advisor with Province Mortgage Associates, and an Adjunct Professor with the University of New Haven and Roger Williams University.  He can be reached at (401) 263-8655 or by leaving a comment on this article.