An interesting Fed blog asks the question why mortgage rates, already quite low (3.3% around the time of the publication) aren’t even lower? The reason for the question is that the spread between rates on new mortgages and those trading in the financial markets as bundled “mortgage-backed securities” (MBS) had widened. If new mortgages had moved in tandem with the MBS market, new mortgages would be originating with 2.6% rates.

The authors suggest a number of explanations:

• MBS yield is computed, implying that the observed MBS rate may have some sampling error
• Guarantee fees on loans charged by Fannie and Freddie have increased
• Compensation required for increased put-back risk
• Higher hedging costs
• Higher loan production expenses
• Declining value of mortgage service rights

It appears that the answer is not fully on the cost side, and that means that at least part of the spread represents wider profit margins.

• Underwriters do have increased pricing power, particularly on the refinancing side
• Originator capacity constraints, declining third party originations, lack of underwriters means underwriters may not be able to lower rates to pick up higher volumes
• Uncertainty regarding future volumes, future regulations, and future liabilities may keep underwriters from getting to aggressive on pricing and new entrants from entering the fray

The authors conclude that while some of the spread may be structural, there is some room for spreads to narrow and perhaps we could see 3% mortgages if not 2.6%.