Federal Reserve officials have complained for years that the rest of the government is impeding the effectiveness of monetary policy. The Fed keeps making it cheaper to borrow, but the nation’s favorite kind of borrowing is the mortgage loan, and the mortgage market — well, let’s just say it’s a little broken.
In the latest variation on this important theme, researchers at the Federal Reserve Bank of New York presented evidence in a recent paper that a government policy aimed at helping underwater borrowers also is helping lenders pad profits, reducing the benefits for borrowers — and the economy.
Notwithstanding such frustrations, the Fed’s policy-making committee is expected to announce Wednesday afternoon that it will keep buying Treasury securities and mortgage-backed securities to stimulate the economy.
There is ample evidence that asset purchases work, at least a little. The new Fed study simply adds to the list of reasons that it does not work better.
The federal government encourages mortgage companies to refinance borrowers whose debts exceed 80 percent of the value of their homes by instructing Fannie Mae and Freddie Mac to buy the new loans and to relax some of their usual conditions and safeguards. But the Home Affordable Refinance Program offers those terms only to the company controlling the original loan.
This unique financial advantage means lenders can charge higher interest rates while still underpricing potential competitors. The Fed study calculates that average rates are about 0.5 percentage points higher than on comparable loans.
That’s a problem for two reasons. First, it limits the number of people who can benefit from refinancing. Second, it means borrowers are saving less money. Instead, banks are booking larger profits — and much of the money either leaves the country or sits on balance sheets, waiting for brighter days. Borrowers, by contrast, are much more likely to take their savings and spend it.
The Fed announced in September that it would expand its holdings of mortgage-backed securities by about $40 billion a month until the outlook for the job market showed “sustained improvement.” The purchases are akin to removing multiple seats from a game of musical chairs. Other buyers are forced to accept lower interest rates — that is, they are forced to pay upfront a larger share of the money they are entitled to receive as the bond matures.
That reduces interest rates for borrowers, too. Borrowers pay higher rates to lenders than lenders pay to investors. That’s how lenders make money. But as investors charge less, lenders also can charge less without sacrificing profit.
The average rates that lenders charge borrowers, however, have fallen by less than the average interest rates that investors demand from lenders. Over the last decade, the median difference was about 0.4 percentage point, according to Bloomberg News. It now stands at more than 1.2 percentage points.
In other words, as my colleague Peter Eavis wrote in August, the Fed’s campaign is helping lenders much more than it’s helping borrowers.
That 3.55 percent rate for a 30-year mortgage could be closer to 3.05 percent if banks were satisfied with the profit margins of just a few years ago. The lower rate would save a borrower about $30,000 in interest payments over the life of a $300,000 mortgage.
The question is why: If profit margins have grown so fat, why aren’t some lenders trying to win business by offering lower prices? One popular theory is that the financial crisis decimated the ranks of lenders, but the New York Fed calculates that competition actually has increased over the last year. Another theory is that lenders lack the capacity to meet demand for loans, so they have little incentive to compete by cutting prices. The study discounts that explanation, too.
Instead, the study suggests that many borrowers do not benefit from competition because companies will make loans only with government subsidies, and the government is offering to subsidize only one lender for each borrower.
In addition to the evidence that companies are charging higher interest rates on HARP loans, the study found evidence of similar pricing in a companion program for people who owe less than 80 percent of a home’s value.
Notwithstanding these frustrations, the Fed is likely to persist in its efforts because officials remain convinced that buying mortgage bonds is the best way to reduce mortgage rates, and reducing mortgage rates is the best way to help the economy.
As William C. Dudley, the New York Fed president, put it in a recent, typically understated summation, “our policy has been and continues to be effective — though it is certainly not all-powerful in current circumstances.”
Article source: http://economix.blogs.nytimes.com/2012/12/12/another-asterisk-for-asset-purchases/?partner=rss&emc=rss
