By NICK TIMIRAOS
The Federal Reserve's intensified campaign to push mortgage rates lower has hit a wall, in part because a shift in the lending landscape has made some banks unable, or unwilling, to pass along cheaper credit.
Since the Fed began buying mortgage-backed
securities to lower interest rates four years ago, rates on 30-year fixed-rate
mortgages have fallen nearly three percentage points and averaged 3.37% last
week, according to Freddie Mac FMCC -0.70%.
While current rates are the lowest in generations, some economists argue that
they should be even lower—perhaps 2.8% based on the historical relationship
between mortgage rates and yields on mortgage-backed securities. The economists
posit that banks are keeping the rates artificially high, boosting profits and
depriving the economy of the full benefit of the Federal Reserve's efforts.
Lenders profit on the gap, or spread, between their cost of obtaining money and the rate they charge when lending it out. Before the financial crisis, this spread averaged around 0.5 percentage point and widened to about 1 percentage point in the years after 2008. In October, after the Fed embarked on a new round of mortgage bond purchases, the spread leapt to 1.6 points and currently is hovering around 1.3 points.
There are numerous, and complex, reasons for the difference. More volume, for example, is moving through an industry that has shrunk significantly. At the same time, banks today are scrutinizing property appraisals and loan files more closely—requiring reams of documentation of borrowers' assets, to guard against the cost that they will be forced to buy back any defaulted mortgages from Fannie and Freddie. That means fewer underwriters are spending more time on every loan.
Federal Reserve Chairman Ben Bernanke
underscored earlier this month that other changes in the mortgage industry were
contributing to higher spreads, including higher fees charged by
mortgage-finance giants Fannie Mae FNMA 0.00%and Freddie Mac, and reduced capacity in
the industry. "Most of those things…are not really in our control," Mr. Bernanke
said at a press conference.
As a result, at a time when there are fewer people processing loans—mortgage
banking employment has fallen by more than 50% from its peak in 2006—the amount
of time it takes to process loans has gone up. Loan underwriters processed
around 60 retail applications per month last year, compared to 190 applications
per month in 2002, according to the Mortgage Bankers Association."The Federal Reserve is sitting there opening up the spigot as much as they can, and then you have someone at the other end of the hose squeezing it tighter and tighter, and a trickle gets through," said Christopher Mayer, a Columbia Business School economist.
Traditionally, easing mortgage rates is a key way for the Federal Reserve to stimulate the economy because the move triggers a mortgage refinancing wave that allows homeowners to slash hundreds of dollars from their monthly payments, freeing up cash that can be spent in other sectors of the economy. "But if you have lenders who are not passing through the savings, then more of the benefits of low rates are going to lenders," said Thomas Lawler, an independent housing economist in Leesburg, Va.
The result is that bank revenues are soaring but the broader economy isn't feeling the full effect.
Consumers don't appear to have noticed "because rates are so low that nobody's complaining about getting a 3.5% mortgage," says Guy Cecala, publisher of Inside Mortgage Finance, a trade publication.
The problem is especially important now because Fed officials have ramped up their efforts to support the housing market in recent months. In September the Fed announced it would buy $40 billion a month of mortgage backed securities until the job market improves and earlier this month the Fed reaffirmed its commitment to keep buying in 2013.
Officials have started to raise concerns. The bond buying "would have had still more effect on the economy" if banks were passing through lower rates to consumers, said William Dudley, president of the Federal Reserve Bank of New York in an October speech.
Some say the higher spreads reflect bank profiteering. A study from the New York Fed earlier this month calculated that banks earn about $5 per $100 in loans they originate today, up from $4 in 2009 and $2 from 2005-2008. The revenues have been especially pronounced, economists wrote, on certain government refinance programs that make it harder for borrowers to refinance with a new lender, limiting competition.
Commercial banks reported a record $9.4 billion in income from mortgage-banking during the third quarter of 2012, according to an analysis of data by Inside Mortgage Finance, which says it is the highest since it began tracking such data in 2002. The third-quarter figure was up 18.7% from the second quarter and 72.3% from one year ago, and it was more than what the industry earned in 2007 and 2008 combined.
Higher spreads are partly a function of an industry
that has seen large banks cut back on buying loans from smaller lenders,
focusing instead on their retail business. In the past 18 months, dozens of
lenders have exited mortgage lending or sharply cut back their mortgage-banking
units, including Bank of America,
BAC -1.82%MetLife MET -0.66%and GMAC Mortgage, a unit of Ally
Financial Inc. High barriers to entry, including new lender net worth
requirements and uncertainty over new regulations, have kept out new
entrants.
"If you open up a restaurant that seats 100 people,
and you have 100 people out the door, your first thought is not to drop your
prices," says Scott Simon, who heads the mortgage-backed securities group at
Pacific Investment Management Co., or Pimco, a unit of Allianz SE ALV.XE +0.33%.
In past cycles when rates dropped, banks would hire new staff "and throw them
on the front lines as fast as they could," says Paul Miller, a banking analyst
at FBR Capital Markets. Today, by contrast, the industry is "unable, and in some
cases unwilling, to expand to meet the current demand for mortgages," he
says.Lenders say they are reluctant to staff up given the prospect that any uptick in rates would choke off refinancing, leaving them with lots of overhead but little new business. Staffing also takes longer than it used to thanks to new state licensing requirements.
Mortgage industry officials say that rising litigation expenses, federal and state investigations, and new regulations have created a cost structure that is difficult to predict. "Until we have a rational, articulated plan where institutions know they can extend credit in a way that protects them as well as the consumer, I think we're going to see these spreads stay wide," said David Stevens, chief executive of the Mortgage Bankers Association. For a bank, "almost any other investment is a better choice right now [than mortgages], unless margins create a cushion to protect against this huge uncertainty premium."
A federal lawsuit filed by the U.S. government
against Wells Fargo WFC -1.37%in October helps explain lenders'
caution. The bank was accused by authorities of reckless lending, in part, for
maintaining a "singular focus on increasing volume" between 2001 and 2005 that
led to improper loan approvals. Management had hired "temporary staff to churn
out and approve an ever-increasing quantity of [government-insured] loans" and
failed "to provide its inexperienced staff with proper training." Wells Fargo
has denied the allegations and asked a judge last month to dismiss the
lawsuit.
Write to Nick Timiraos at nick.timiraos@wsj.com
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