By Jonathan Spicer and Leah Schnurr
NEW YORK (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 Fannie Mae
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.
"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.
The Fed wants to know what role put-back risk - the possibility underwriting of a loan violates Fannie and Freddie 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 show 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.
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 Mae and Freddie Mac senior vice presidents Anthony Reed and Stephen Clinton, respectively, as well as Matt Jozoff of JPMorgan Chase & Co
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.
JUST PASSING THROUGH
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, in QE3.
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.
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 September 13 its third round of quantitative easing, dubbed QE3, however, the spread temporarily spiked to more than 1.5 percent.
William Dudley, the New York Fed president and a former partner at Goldman Sachs, has said that QE3 would have had a more pronounced effect on the economy if "pass-through" rates between the secondary and primary markets were higher.
The incomplete pass-through, he said in October, is due in part to "a concentration of mortgage origination volumes at a few key financial institutions, and mortgage rep and warranty requirements that discourage lending for home purchases, and make financial institutions reluctant to refinance mortgages that have been originated elsewhere."
(Reporting by Jonathan Spicer and Leah Schnurr; Editing by Andrea Ricci)