With its recent new initiative to inject a potentially unbounded amount of additional stimulus into the economy, the Federal Reserve is pulling out all the stops to try to get the economy moving forward again. But recent evidence suggests that some of the people that the Fed has targeted to get the benefit of its moves aren't getting the full beneficial impact because of interference from other sources who are tapping Fed policies for their own profit.
In particular, with the Fed expressly targeting mortgage-backed securities for its latest round of quantitative easing, the central bank clearly wants to help homeowners who are underwater on mortgages and struggling to refinance their outstanding loans. Yet as a report in The New York Times recently noted, interest rate reductions in the mortgage-backed securities market that would ordinarily put homeowners in a position to get favorable mortgages simply aren't flowing through to mortgage borrowers.
Spreading the profits around
In the distant past, banks made home loans with the intention of holding on to them. As a result, banks were highly interested in the creditworthiness of their customers, since they'd potentially be on the hook if those customers couldn't pay. As the Times article explains, however, the ability to sell mortgage loans onto the open market where they could then be turned into mortgage-backed securities changed the way that banks profited from home loans. It also changed the incentives the banks had for ensuring high-quality loans.
Because the mortgage-backed securities market has become so large, you can use the difference between prevailing rates on those securities and the mortgage rates that banks offer to gauge the amount of profit that banks are collecting on home loans. As recently as a year ago, the spread between those two rates was about three-quarters of a percentage point.
Now, though, the spread has nearly doubled, rising above the 1.4 percentage point mark. In other words, banks are reaping a windfall at mortgage borrowers' expense. And if mortgage rates reflected more normal conditions, they'd be almost three-quarters of a point lower than they are today, potentially saving homeowners hundreds of dollars on their monthly payments when they refinanced.
Where's the money?
The obvious place to look for the profits is mortgage lenders. Wells Fargo
But if big banks are running wild, the question you have to ask is why competition isn't holding them in check. One possible reason is that after the financial crisis, mortgage brokers faced intense scrutiny over their business practices. Unlike big banks getting government rescues, mortgage brokers were largely seen as scapegoats, allegedly luring unsuspecting customers in and getting a cut off the top.
Although there were certainly cases of abuse, the impact of the crisis and resulting tighter regulation on surviving mortgage brokers may well have led to the industry swinging too far to the other extreme. Without independent brokers who can shop different lenders with sophistication to find the best rates for their customers, lenders don't have nearly the incentive to cut their rates as much as they can. Instead, they can focus on customer service and relationship building while at the same time trying to widen their profit margins on loan transactions by withholding better rates.
What can you do?
If you're looking for a mortgage, you have to know not just prevailing rates at competing financial institutions but also the current state of the mortgage-backed bond market. A small local bank or credit union may give you your best bet to get a rock-bottom rate.
Homeowners simply need to get more sophisticated. Otherwise, all the Fed's rate moves will be for naught -- unless you're a big bank.
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Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.
