The primary-secondary spread is the difference between mortgage rates for borrowers and yields on newly issued agency mortgage backed securities (MBS). From 2008 to 2012, the spread widened significantly—rising from 50 basis points in 2008 to more than 100 basis points in early 2009 and during 2012. While it is a closely tracked series, the primary-secondary spread is an imperfect measure of the pass-through between secondary-market valuations and primary-market borrowing costs, for instance, because the secondary yield is subject to model misspecification.
In “The Rising Gap between Primary and Secondary Mortgage Rates,” Andreas Fuster, Laurie Goodman, David Lucca, Laurel Madar, Linsey Molloy, and Paul Willen shed light on this pass-through by examining cash flows during and after the mortgage origination and securitization process to determine the share of dollars absorbed by originators, either to cover costs or as originator profits. They calculate a series of “originator profits and unmeasured costs” (OPUCs) and show that it increased significantly between 2008 and 2012. The authors determine that the rise in OPUCs was mainly driven by higher MBS prices, which were only partially offset by corresponding increases in origination costs, suggesting that originators’ profits likely rose over this period.
The authors also assess possible sources behind the increase in profitability. They conclude that capacity constraints likely played a significant role in enabling originator profits, especially during the early stages of refinancing waves. Pricing power owing to switching costs of borrowers looking to refinance could have been another factor sustaining originator profits.
Andreas Fuster and David Lucca are senior economists in the Federal Reserve Bank of New York’s Research and Statistics Group; Laurie Goodman is the center director of the Housing Finance Policy Center at the Urban Institute; Laurel Madar and Linsey Molloy are associates in the Bank’s Markets Group; Paul Willen is a senior economist and policy advisor in the Federal Reserve Bank of Boston’s Research Department.
(This article is a revised version of a white paper originally prepared as background material for the workshop “The Spread between Primary and Secondary Mortgage Rates: Recent Trends and Prospects,” held at the Federal Reserve Bank of New York on December 3, 2012.)