Econintersect: New York Federal Reserve Bank president William C. Dudley said that the U.S. mortgage market is from competitive. Dudley addressed the National Association for Business Economics Annual Meeting, New York City, Monday 15 October 2012. Ddudley’s theme centered on the less than robust U.S. economic recovery. One specific area he addressed was housing and, specifically, the mortgage market. But before we look at why he sees that as problematic, let’s look at his overall view of concerns.
Dudley said he saw four possible reasons for the slow recovery:
One possibility is that the negative dynamics of a post-bubble environment are even more potent than had been appreciated. Feedback loops may be more powerful and frictions may be larger. In the U.S. case, this is particularly germane with respect to housing and mortgage finance. For example, we have found significant shortcomings in those institutional structures available to support the workout of the overhang of mortgage debt in an efficient and timely manner.
A second reason may be the series of additional negative shocks experienced since the initial phase of the financial crisis. The largest of these relate to the crisis in the eurozone. But one could also add the periodic commodity price shocks, the disruptive impact of the tragic Japanese earthquake and tsunami on global trade and production, and the effect of the uncertainties around the impending fiscal cliff on hiring and investing.
That said, the shocks since the acute phase of the crisis in the United States were not uniformly negative. Take, for example, the sharp increase in U.S. oil and natural gas production stemming, in part, from the innovations in drilling and extraction technologies. Not only does this rising production directly boost real GDP, but also the large drop in natural gas prices has significantly improved the industrial competitiveness of U.S.-based businesses.
A third reason for the weaker than expected recovery likely lies in the interplay between secular and cyclical factors. In particular, I believe that demographic factors have played a role in restraining the recovery. The developed world’s populations are aging rapidly. In the United States, for example, the baby boom generation, which is a particularly large cohort, is now beginning to retire. As the population ages, this has two consequences. First, the spending decisions of the older age cohorts are less likely to be easily stimulated by monetary policy. That is because such age groups tend to spend less of their incomes on consumer durables and housing. Second, as the population ages and the number of retirees climbs, the costs associated with Social Security, government pensions, and healthcare retirement benefits increase. This creates budgetary pressure and leads to a choice of raising revenue to fund these costs, cutting other government programs, or cutting benefits.
Now if this all had been fully anticipated by retirees and near-retirees, then this would already be factored into their spending and saving decisions. But, I doubt that this has been the case. I suspect that many have been surprised by the swift change in economic circumstances as the housing boom went bust. I doubt that many fully anticipated the budget crunch and the prospect that their future retiree and healthcare benefits would likely be curbed or their taxes would have to rise in the future. When households begin to anticipate this, they reduce their assessment of their sustainable living standards. This downward reassessment then feeds back to current spending and saving decisions.
A fourth reason why the recovery has been slower than expected may be that we overestimated the capacity for fiscal policy to continue to provide support to growth until a vigorous recovery was achieved. On the fiscal side, the authorities can cut taxes or increase spending to support income and demand during the deleveraging phase that follows the financial crisis. But the ability of such stimulus to continue to support economic activity ultimately encounters budgetary limits. For example, the need to keep the long-term fiscal trajectory on a sustainable path limits the size and duration of federal fiscal stimulus measures. For state and local governments, the statutory requirements for balanced budgets meant that fiscal policies turned restrictive relatively quickly once budget surpluses and rainy day funds were exhausted, and this was only temporarily mitigated by federal transfers to the states as part of the initial fiscal stimulus program. Fiscal policy is now a drag rather than a support to growth in the United States, and this will likely continue.
Nowhere in the overview did Dudley specifically mention housing and mortgages. But later on in the speech he got into details. Referring to the recently implemented QE3:
Federal Reserve MBS [mortgage backed securities] purchases have succeeded in driving down mortgage rates to historically low levels. But these purchases would have had still more effect on the economy if pass-through rates from the secondary market to the primary market had been higher.
Dudley displayed the following graph which shows that with the advent of QE3 the spread between agency MBS (Fannie and Freddie) and Treasuries is close to zero. Looks like the latest monetary action is having the desired effect of lowering mortgage rates:
But then he showed a second graph and what do we see? The spread between primary MBS and agency securities has widened quite significantly. If the Fed has the objective of lowerung mortgage interest rates for home owners the program looks like a failure. What has resulted is a widening of the carry interest for mortgage originators:
Dudley attributed at least part of the undesired effect to a lack of competition:
The incomplete pass-through from agency MBS yields into primary mortgage rates is due to several factors—including 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. On a related note, higher guarantee fees charges by Fannie Mae and Freddie Mac have increased the fixed cost of originating loans and this has also increased the spread between primary and secondary mortgage rates. Factors limiting pass-through warrant ongoing attention from policymakers.
Once again the benficiaries of monetary easing are the monopolistic mega-banks.
- The Recovery and Monetary Policy (William C. Dudley, speech, 15 October 2012)