The NYT has an interesting article today reporting the views of several economists on how much further they expect house prices to fall. One of the economists, Christopher Mayer, argued that the extraordinary spread between mortgage rates and the interest rates on Treasury bonds has been a substantial factor depressing prices. The comments seem to imply that when the mortgage market settles down there will be a reduction in this spread giving a boost to house prices. Actually, what is unusual at present is not the spread between mortgage interest rates and Treasury yields, but rather the unusually low real yield on Treasury bonds. The real return on the 10-year Treasury bond is currently negative, with the interest rate around 3.9 percent and the inflation rate around 4.5 percent. This is extraordinary. Typically, the real return on the 10-year Treasury has been in the range of 2-4 percent. The low current return on Treasury bonds is due largely to the fact that foreign central banks, most importantly China's, are consciously trying to prop up the dollar and the U.S. economy by buying vast amounts of U.S. Treasury bonds. They are doing this to sustain their export markets to the United States. In exchange, they have been willing to take enormous losses on their holdings of Treasury bonds. This is not a typical situation and will presumably not persist indefinitely. When foreign central banks no longer feel the need to prop up the dollar and hold down U.S. Treasury rates it is likely that the yield on Treasuries will rise, thereby closing the gap with mortgage interest rates. The real interest rate on mortgages of approximately 2.0 percent, is actually quite low by historical standards. It typically is in the range of 3.0-4.0 percent.
--Dean Baker
