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Fed Attempts To Quantify Why Mortgage Rates Lag MBS Improvements
The Federal Reserve Bank of New York held a workshop
today on The Spread between Primary and Secondary Mortgage Rates: Recent Trends and Prospects. William Dudley, the Bank's president told
participants the bank had organized the workshop because the topic of the primary-secondary mortgage rate spread is
important for current efforts by the Federal Open Market Committee (FOMC) to
foster faster economic growth.
Because unemployment remains high,
the FOMC took action at its September meeting to provide additional monetary
accommodation including a new program to purchase an additional $40 billion a
month of agency mortgage-backed securities (MBS) and in October it announced it
will continue its purchases of agency MBS, undertake additional asset
purchases, and employ its other tools as appropriate until there is a
substantial improvement in the outlook for the labor market in a context of
price stability.
Dudley explained that the impact of monetary
policy on economic activity depends on the extent it is effectively transmitted
to key sectors of the economy and MBS purchases affect the economy most effectively
through the housing and mortgage markets, lowering the secondary market rate at
which mortgage-backed securities trade and putting downward pressure on the
primary mortgage interest rate. This in turn enables borrowers to
refinance at lower rates and increases demand for home purchases, thus
supporting house prices and household wealth, which in turn may increase access
to credit.
This has indeed happened since the
September FOMC meeting, Dudley said. Yields
on new agency MBS are down about 45 basis points and the Freddie Mac survey 30-year
primary rate has declined 23 basis points to 3.32 percent. The declines
are even larger if dated from the August FOMC meeting when expectations of
easing increased.
But this easing has been impeded by
two factors. Dudley called the credit
standards for mortgages since the housing bust "overcorrected" and said, coupled
with the number of underwater mortgages it is impossible for some people to
take advantage of the low interest rates.
But the purpose of the workshop, he
said, is to focus on the second impediment; the significant widening of the
spread between yields on MBS in the secondary market and primary mortgage
rates. In order for actions taken by
FOMC to have their full impact on the economy, they need to pass through from
the secondary to the primary rate. "To the extent that the primary-secondary rate
spread widens, the reduction in pass-through limits the full impact of the
policy actions."
The spread through the late 1990s
and early 2000s was in the range of 30 to 50 basis points but more recently and
especially in the past 18 months the spread has increased substantially and
after the September FOMC meeting it rose above 150 basis points. This spike was not surprising, Dudley said, because
the primary market may be slower to react and it has now retracted to its pre-meeting
level of about 120 basis points which is still high by historic standards.
[Image or graph removed from email. View full article with images]
The spread is influenced by a number
of elements such as the value attached to servicing rights and the annual GSE
guarantee fee which has increased in what Dudley called a necessary and overdue
re-pricing of the credit guarantee provided to investors. While they differ by mortgage and by seller,
the average effective guarantee fee has increased from 20 to 25 basis points to
nearly 50 basis points today but that still leaves a significant part of the
spread to be otherwise explained.
[Image or graph removed from email. View full article with images]
Dudley referenced the new study on
the subject, The Rising Gap between
Primary and Secondary Mortgage Rates written by several Fed staff among
others and available here,
and summarized it for his audience. The study,
he said, comes up with a measure of originator profits and unmeasured costs or OPUCs
and evaluates a number of factors that could explain the historically elevated
levels of the latter. The study concludes:
"The rise in OPUCs is mainly
driven by higher MBS prices,
which are not offset by corresponding increases in measurable
costs. Conversely, a decline in the value of mortgage servicing
rights may have reduced OPUCs to some extent, and thus contributed to the widening primary-secondary spread. Among harder-to-measure costs, we find that putback risk and pipeline hedging likely cannot explain the full rise in OPUCs. Absent other cost increases
that we cannot measure well, such as operating
costs, the rise in OPUCs reflects to some extent an increase in originator profits.
While market concentration alone does not seem to explain the rise in these profits,
capacity constraints do appear to play a significant role. Additionally, we provide evidence
suggesting that originators have enjoyed pricing power on some of their borrowers looking to refinance over the past year."
The financial crisis and the housing
bust created headwinds to the recovery in part through adverse impacts on the
mechanisms of monetary policy transmission. It is important, he
concluded, that the forces that have been acting on the primary-secondary
spread be correctly identified and, to the extent possible, quantified. He urged the workshop participants to bring
their broad range of informed perspectives to the table and be as open, frank
and precise in their discussions in order to draw some conclusions about the
factors influencing the spread. .
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Fed Attempts To Quantify Why Mortgage Rates Lag MBS Improvements
The Federal Reserve Bank of New York held a workshop
today on The Spread between Primary and Secondary Mortgage Rates: Recent Trends and Prospects. William Dudley, the Bank's president told
participants the bank had organized the workshop because the topic of the primary-secondary mortgage rate spread is
important for current efforts by the Federal Open Market Committee (FOMC) to
foster faster economic growth.
Because unemployment remains high,
the FOMC took action at its September meeting to provide additional monetary
accommodation including a new program to purchase an additional $40 billion a
month of agency mortgage-backed securities (MBS) and in October it announced it
will continue its purchases of agency MBS, undertake additional asset
purchases, and employ its other tools as appropriate until there is a
substantial improvement in the outlook for the labor market in a context of
price stability.
Dudley explained that the impact of monetary
policy on economic activity depends on the extent it is effectively transmitted
to key sectors of the economy and MBS purchases affect the economy most effectively
through the housing and mortgage markets, lowering the secondary market rate at
which mortgage-backed securities trade and putting downward pressure on the
primary mortgage interest rate. This in turn enables borrowers to
refinance at lower rates and increases demand for home purchases, thus
supporting house prices and household wealth, which in turn may increase access
to credit.
This has indeed happened since the
September FOMC meeting, Dudley said. Yields
on new agency MBS are down about 45 basis points and the Freddie Mac survey 30-year
primary rate has declined 23 basis points to 3.32 percent. The declines
are even larger if dated from the August FOMC meeting when expectations of
easing increased.
But this easing has been impeded by
two factors. Dudley called the credit
standards for mortgages since the housing bust "overcorrected" and said, coupled
with the number of underwater mortgages it is impossible for some people to
take advantage of the low interest rates.
But the purpose of the workshop, he
said, is to focus on the second impediment; the significant widening of the
spread between yields on MBS in the secondary market and primary mortgage
rates. In order for actions taken by
FOMC to have their full impact on the economy, they need to pass through from
the secondary to the primary rate. "To the extent that the primary-secondary rate
spread widens, the reduction in pass-through limits the full impact of the
policy actions."
The spread through the late 1990s
and early 2000s was in the range of 30 to 50 basis points but more recently and
especially in the past 18 months the spread has increased substantially and
after the September FOMC meeting it rose above 150 basis points. This spike was not surprising, Dudley said, because
the primary market may be slower to react and it has now retracted to its pre-meeting
level of about 120 basis points which is still high by historic standards.
The spread is influenced by a number
of elements such as the value attached to servicing rights and the annual GSE
guarantee fee which has increased in what Dudley called a necessary and overdue
re-pricing of the credit guarantee provided to investors. While they differ by mortgage and by seller,
the average effective guarantee fee has increased from 20 to 25 basis points to
nearly 50 basis points today but that still leaves a significant part of the
spread to be otherwise explained.
Dudley referenced the new study on
the subject, The Rising Gap between
Primary and Secondary Mortgage Rates written by several Fed staff among
others and available here,
and summarized it for his audience. The study,
he said, comes up with a measure of originator profits and unmeasured costs or OPUCs
and evaluates a number of factors that could explain the historically elevated
levels of the latter. The study concludes:
"The rise in OPUCs is mainly
driven by higher MBS prices,
which are not offset by corresponding increases in measurable
costs. Conversely, a decline in the value of mortgage servicing
rights may have reduced OPUCs to some extent, and thus contributed to the widening primary-secondary spread. Among harder-to-measure costs, we find that putback risk and pipeline hedging likely cannot explain the full rise in OPUCs. Absent other cost increases
that we cannot measure well, such as operating
costs, the rise in OPUCs reflects to some extent an increase in originator profits.
While market concentration alone does not seem to explain the rise in these profits,
capacity constraints do appear to play a significant role. Additionally, we provide evidence
suggesting that originators have enjoyed pricing power on some of their borrowers looking to refinance over the past year."
The financial crisis and the housing
bust created headwinds to the recovery in part through adverse impacts on the
mechanisms of monetary policy transmission. It is important, he
concluded, that the forces that have been acting on the primary-secondary
spread be correctly identified and, to the extent possible, quantified. He urged the workshop participants to bring
their broad range of informed perspectives to the table and be as open, frank
and precise in their discussions in order to draw some conclusions about the
factors influencing the spread. .
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