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In the primary mortgage market, lenders make loans to borrowers at a certain interest rate, whereas in the secondary market, lenders securitize these loans into mortgage-backed securities (MBS) and sell them to investors.
When thinking about the relationship between these two markets, policymakers and market commentators usually pay close attention to the “primary-secondary spread.”
From 2008 to 2012, the spread widened significantly—rising from 50 basis points in 2008 to more than 100 basis points in early 2009 as well as during 2012.
Although 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 example, because the secondary yield is subject to model misspecification.
To describe changes in the pass-through over time, Fuster et al. examine cash flows during and after the mortgage origination and securitization process to determine how many dollars (per $100 loan) are absorbed by originators, either to cover costs or as originator profits.
The authors calculate a series of originator profits and unmeasured costs (OPUCs) for 1994-2012, and show that OPUCs increased significantly between 2008 and 2012.
They 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.
Fuster et al. also assess possible reasons for 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.
About the Authors
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.
The views expressed in this summary are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System.