UPDATE 1-Fed to hold lenders' feet to the fire on mortgages
NEW YORK, Dec 3 (Reuters) - Frustrated Federal Reserve policymakers on Monday sought an explanation from mortgage lenders as to why the benefits of lower interest rates were not filtering to home buyers as quickly as in the past even as investors benefited.
At an all-day New York Fed workshop, officials from Wells Fargo & Co, JPMorgan Chase & Co and other big lenders will be asked why there is a growing disconnect between the rates Americans pay on home loans and the yields on mortgage-backed securities (MBS).
The question has puzzled central bank policymakers who worry the situation is undercutting their efforts to stimulate the country's slow economic recovery from recession.
Since September, when the Fed targeted the U.S. mortgage market with its latest round of large-scale bond purchases, the closely watched spread between the interest rates homeowners pay and what investors reap on mortgage-backed securities has widened to record levels.
The Fed's purchase of $40 billion per month in agency MBS has made a big splash in the secondary market. Yet in the primary market, the drop in the mortgage rates that home buyers can get from lenders has not been as pronounced as the central bank wanted, lagging historical trend.
This clog in the passage between the primary and secondary markets undermines an important reason for the Fed's monetary stimulus: kick-starting a housing sector that was at the heart of the 2007-2009 financial crisis and that has only just begun to show some life.
"The impact of monetary easing on the economy through housing and mortgage finance has been impeded to some degree" by the primary-secondary rate spread, William Dudley, president of the New York Fed, said at the workshop.
The Fed wants to know what role so-called put-back risk - the possibility that underwriting of a loan violates Fannie Mae and Freddie Mac guidelines, forcing a bank to repurchase it from the agencies - plays in the widening spread between secondary and primary markets.
It also wants to know what role bank profit plays.
In a paper published last week, Fed researches showed that the market value of the typical offered mortgage has quadrupled in the last five years. That implies, they argue, either a parallel rise in a lender's profits or its costs, or a rise in both profits and costs.
Pointing to findings of the paper, Dudley said it "suggests that originator profits may have increased," and that mortgage originators "enjoy pricing power and elevated profits" on refinancings including the Home Affordable Refinance Program (HARP), a federal program meant to help stressed borrowers refinance their mortgages.
For Fed policy to be as effective as possible "it is imperative that the key channels of the monetary policy transmission mechanism are operating as effectively as possible," Dudley said.
"The financial crisis and the housing bust created headwinds to the recovery in part through adverse impacts on the mechanisms of monetary policy transmission."
JUST PASSING THROUGH
The New York and Boston branches of the central bank are co-hosting the Monday workshop, held just a couple blocks from Wall Street. Boston Fed President Eric Rosengren, a voter next year on central bank policy, is set to give a keynote speech.
Among those on the hot seat are Fannie and Freddie senior vice presidents Anthony Reed and Stephen Clinton, respectively, as well as Matt Jozoff of JPMorgan, Mohan Chellaswami of Wells Fargo and Kenneth Adler of Citigroup Inc, among others.
Stakeholders in the MBS market will also take part in panel discussions, including Scott Simon from bond-fund giant PIMCO. Keith Ernst, associate director at the Federal Deposit Insurance Corporation, is also on the list of speakers.
While the housing market has turned a corner this year with prices rising, access to credit has been tight, potentially limiting how much the market can recover if would-be home buyers are shut out.
Although the housing market has led the broader economy out of recessions in the past, the sector has been absent from the current recovery until recently. Fed Chairman Ben Bernanke has pointed to this "missing piston" in the U.S. economic recovery in defending the choice of buying mortgage bonds, and not Treasuries.
A move toward more conservative underwriting standards since the mortgage-market-inspired financial crisis explains part of the widening spread between primary and secondary yields. A concentration of mortgage originators since the crisis explains another part.
"There is clearly something that is manifesting as a form of constraint," Jeremy Stein, a Fed governor, said when asked about mortgage lending at a Boston conference on Friday.
"For me it's a little hard to unpack exactly what the mechanisms are, but I think it's something that deserves a fair amount of attention."
Stein highlighted odd differences in the availability of credit, depending on the type of loan, where lenders seem to treat mortgages more conservatively than they do auto loans made to the same household. "Whether it's a regulatory or a put-back risk ... there's clearly just quantitatively not the volume happening," he said.
Before 2000, the spread between yields on newly issued agency MBS in the secondary market, and an average of mortgage loan rates from the Freddie Mac Primary Mortgage Market Survey in the primary market was mostly stable at about 0.3 percent.
That widened to a new equilibrium at about 0.5 percent between 2000 and 2008, before doubling the following year, according to the Fed paper.
Immediately after the central bank announced on Sept. 13 its third round of quantitative easing, dubbed QE3, however, the spread temporarily spiked to more than 1.5 percent.
Today, the spread has declined to its pre-QE3 level of about 1.2 percent, yet it remains lofty by historical standards.
In October, Dudley argued that QE3 would have had a more pronounced effect on the economy if "pass-through" rates between the secondary and primary markets were higher, citing a concentration of mortgage origination volumes "at a few key financial institutions."