NY Fed -- As of mid-December, the average thirty-year fixed-rate mortgage was near its historic low of about 3.3 percent, or half its level in August 2007 when financial turmoil began. However, yield declines in the mortgage-backed-securities (MBS) market, where bundles of mortgage loans are sold to investors, have been even more dramatic. In fact, all else equal, had these declines passed through to loan rates one-for-one, the average mortgage rate would now be around 2.6 percent. In this post, we summarize some of the findings from a workshop held at the New York Fed in early December aimed at better understanding the drivers behind the increased wedge between mortgage loan and MBS rates.
The chart below shows the recent evolution of the gap between the two rates (the “primary-secondary spread”) as measured by the difference between a representative yield on newly issued agency MBS (the “current coupon,” or secondary rate) and the average thirty-year fixed loan rate (the “primary rate”) from the Freddie Mac Primary Mortgage Market Survey. The spread has increased 70 basis points, on net, from around 45 basis points in 2007 to about 115 today, implying that declines in the primary rate have been smaller than those in the secondary rate. So, why is the primary rate at 3.3 percent and not at 2.6 percent today?
As we noted in a white paper prepared as background material for the workshop, a number of factors may be at play. First, the primary-secondary spread is only an imperfect proxy for the degree of “pass-through” between the MBS market and the primary market. For one thing, we can’t observe the MBS yield directly, but instead must compute it under a number of assumptions that are particularly sensitive to misspecification in the current environment. Also, the spread doesn’t take into account the guarantee fees on loans charged by Fannie Mae or Freddie Mac (the agencies or “GSEs”), which have increased from 20 to 25 basis points before 2008 to about 50 basis points today.
Rising Cost or Rising Profit?
A clearer picture of the link between MBS and primary markets comes from an alternative measure that we call “Originator Profits and Unmeasured Costs,” or OPUCs. The OPUC measure captures the loan originator’s average revenue from selling a mortgage in the agency MBS market (after accounting for the guarantee fee) as well as the revenues from servicing the loan and from points paid upfront by the borrower. As the name implies, OPUCs represent either lender costs (other than the guarantee fee), lender profits, or a combination of the two.
Recent movements in OPUCs, shown in the chart below, are similar to those in the primary-secondary spread. OPUCs have increased significantly, from below $2 (per $100 loan) in the 2005-08 period to a record high of about $5, suggesting that even after accounting for the higher guarantee fees, something unusual may be occurring in mortgage markets today.