High borrowing costs defy Fed's interest rate cuts

— -- The Federal Reserve Board has pushed short-term interest rates lower, but the credit crunch is raising borrowing costs for corporations and home buyers.

The Fed has nudged its key overnight federal funds rates down to 2% from 5.25% a year ago to stimulate the economy. Yields on Treasury securities, which have virtually no credit risk, have fallen, too. Uncle Sam can borrow money for 10 years at 3.82%, vs. 4.67% a year ago.

But 30-year fixed mortgage rates, which often follow the 10-year T-note yield closely, have barely budged the past 12 months, and have risen since the first of the year. Thirty-year fixed-rate mortgages averaged 6.52% last week, up from 6.17% Dec. 31, according to mortgage giant Freddie Mac.

The yield spread between mortgage-backed securities issued by Fannie Mae and Treasury securities is now about 1.5 percentage points, adjusted for the effects of mortgage refinancing. "It's a 17-year high," says Robert Auwaerter, head of fixed income at the Vanguard Group. Fannie and Freddie's mortgage-backed securities have averaged about half a percentage point more than Treasuries, he says.

One reason mortgage rates are so high: Fannie Mae and Freddie Mac are buying far fewer mortgages for their own portfolios. The mortgage giants were major buyers in mortgage markets, and lower demand has pushed yields higher.

Corporate borrowers, too, are paying higher interest rates on their bonds. Yield spreads between Treasury securities and corporate bonds are "much wider than usual," says John Lonski, chief economist for Moody's Investors Service. Borrowers are demanding higher yields to offset the risk of default. Those high yields, relative to Treasuries, "warn that the risks facing corporate finances are very substantial," Lonski says.

Corporate borrowers with shaky credit ratings — junk-bond issuers — are being pinched even more. Junk bonds currently yield about 8 percentage points more than Treasuries, Lonski says.

Although that's not as high as the record in 2002, when junk yielded as much as 10 percentage points more than Treasuries, it's worrisome to Lonski because junk yielded about 5.3 percentage points more than Treasuries just three months ago.