When The Fed’s Refi Madness Ended, Bank Mortgage Profits Evaporated

Tyler Durden's picture

Submitted by David Stockman of Contra Corner

When The Fed’s Refi Madness Ended—Bank Mortgage Profits Evaporated

During the course of its massive money printing campaign after the financial crisis of 2008, the Fed drove the 30-year mortgage financing rate down from 6.5% to 3.3% at its mid-2012 low. The ostensible purpose was revive the shattered housing market which had resulted from the crash of its previous exercise in bubble finance.

But what it really did was touch off another of those pointless “refi” booms which enable homeowners to swap an existing mortgage for a new one carrying a significantly lower interest rate and monthly service cost. Such debt churning exercises have been sponsored repeatedly by the Fed since the S&L debacle of the late 1980s.

This time the Fed really outdid itself. During some periods upwards of 80% of new originations were not money purchase mortgages to finance a new home, the declared purpose of interest rate repression, but just refis of existing debt. By resorting to this maneuver to leave more money in the pocket of borrowers each month, our monetary central planners undoubtedly hoped that America’s flagging consumers would buy another flat screen TV, dinner at Red Lobster or new pair of shoes.

Yet two obvious questions recur. First, why does the monetary politburo think that a zero-sum shuffling of shoe purchases into the spring of 2012 and out of 2014 makes any sense? That is the implicit assumption, however, because unless the Fed was prepared to permanently peg the 3.3% refi rate at its mid-2012 level, it was only a matter of time before mortgage rates would rise and household’s buying actual new homes with purchase money mortgages would be paying 4.5% as now, or 6.5% as before the panic, and thereby have far less discretionary cash left over for a trip to Red Lobster.

This cash flow shuffle sounds perfectly silly, of course, but it is essentially what our Keynesian paint-by-the-numbers central bankers are up to because they stubbornly refuse to acknowledge the reality of “peak debt”—especially in the household sector. Yet only a permanent gain in leverage can cause consumer spending to remain elevated in response to monetary stimulus. By contrast, yo-yo-ing the mortgage rate only swaps out cash flow from one arbitrary quarter to the next.

Thus, during the four decades leading up to the financial crisis, the Fed’s interest rate “easing” maneuvers worked because they caused a steady upward ratchet in household leverage ratios. That is, there was still balance sheet space left to hypothecate.  And, as shown below, under the Fed’s post-1970 ministrations, the historically healthy ratio of about 80% debt/wage and salary income climbed parabolically until it peaked at 210% in 2008.

Household Leverage Ratio – Click to enlarge

The above graph also highlights the reason why the Fed is now enmeshed in a pointless exercise of ”yo-yo-ing” the economy in its endless pursuit of accommodation and consumer stimulus. Self-evidently, households have rolled back their leverage ratios to a still historically high and likely unsustainable level of about 180%. So by not permanently adding to their leverage ratio— but actually slowly retrenching it—households have thwarted the Fed’s maneuver to cause a permanent gain in the purchase of shoes and meals at the mall.

And properly so. A continuing rise in the household leverage ratio from the 2008 peak shown above would have led to an even more traumatic retrenchment than that which has already occurred.

But if the Fed’s arbitrary cycle of mortgage rate repression and eventual release—as metered into the financial system by the seers and forecasters resident in the Eccles Building– does not permanently levitate the Main Street economy, it nevertheless leaves an impact: namely, a huge and capricious reshuffling of wealth within both the real economy and the financial system, too. In fact, this wealth reshuffling is so massive and unaccountable that perhaps someday the question will arise as to why the Fed was ever empowered to operate a giant random wealth generator in the first place.

Within the household sector, it is obvious enough that the refi boom benefits only a tiny minority or households—most of which least need help from the state. Stated differently, of the nation’s 115 million households—perhaps 10-15 million have been the lucky recipients of the Fed’s refi maneuver. Clearly the 40 million renters didn’t benefit; nor did the 25-30 million who own their homes free and clear. And upwards of 20-25 million existing mortgage borrowers, who during most of the latest 5-year refi boom were “underwater” or did not have enough positive equity to cover transactions costs and more reasonable down-payment ratios, did not even qualify for the Fed’s lottery.

However, there was one sector that gorged itself on the ”refi” lottery big time—namely, the giant mortgage originating banks on Wall Street who ended up controlling most of the home mortgage market after the Washington assisted mergers during the crisis.  As  summarized in the Fortune article below, the mortgage originators were booking up to $3,300 of up front profit per refi.

And that was just the fee on the transaction—before booking the embedded “gain-on-sale” (often thousands more) when most of this booming mortgage volume was subsequently shuffled off to Freddie and Fannie to be packaged and resold as an MBS. Yes, and at that point, such newly minted “mortgage bonds” did flow back to Wall Street where they were doubtless churned many times over by the dealer side of the banking houses in their endless and remunerative chore of supplying “liquidity” to the homeowners of America.

So the banking side of the Fed’s refi churn did well too—–enjoying a triple profit dip along the way. But there were two untoward effects of these giant windfalls. First, they self-evidently were not a permanent source of bank earnings, as documented by the Fortune article below. JPMorgan’s fee profit per mortgage has now plummeted to a loss of $1,500 each; its mortgage volume has collapsed by upwards of 80%, meaning that fat quarterly profits from “gain-on-sale” into the GSE mills has also evaporated; and its massive trading inventories have been generating losses as often as gains—since bond prices are no longer on a one-way escalator upwards.

The point here is not to lament the resulting sharp decline in the bank earnings from  their triple-dipping mortgage businesses. The windfalls there were no more arbitrary than those captured by households fortunate enough to board the Fed’s refi train while it lasted.

The far more important point is that these were not real economic profits that added permanent value to the American economy.  They were simply central bank enabled “rents” that permitted the big banks to artificially and temporarily repair their balance sheets. The big bank mortgage operations have booked at least $50-$75 billion of this kind of bottled air since the crisis.

And that is were the evil-doing comes in. Based heavily on the windfall of mortgage and fixed income trading profits, the Fed has permitted the Wall Street banks to plunge right back into the business of paying generous dividends and undertaking heavy stock repurchases.  In a word, the very monetary politburo that now says that the solution to financial instability is tougher “prudential” regulation and supervision—rather than the honest thing of slowing down its printing presses—-has engaged in flat-out regulatory folly:  It has permitted Wall Street to re-cycle vast unearned rents to the gamblers and fast money traders who have piled into bank stocks since the crisis.

Instead, it should have been recognized that the giant Wall Street banks are wards of the state. Without access to seven years of deposit funding pegged at zero, the Fed’s discount window privilege in the event of a crisis, and trillions of taxpayer guaranteed deposits, the Wall Street conglomerate banks would not even exist in their current form. So every dime of profit booked—-genuine or windfalls like these—should have been sequestered on their balance sheets until it was truly evident that the “all clear” condition had been reached. Based on first quarter banks results this far, that hardly seems the case.

There was a government anti-drug propaganda movie in the late 1930s called “Reefer Madness”.  It would appear that our monetary politburo has been smoking the same.

By April 11, 2014: 3:37 PM ET


FORTUNE — If you are wondering why you can’t get a mortgage, here’s an answer: Every time JPMorgan Chase makes a home loan, it loses money, $1,500 on average. That might not make JPMorgan want to make so many loans.


That helps explain why banks are lending so little, and why the housing recovery, which seemed to be zooming along just a few months ago, has begun to falter. It also may say something about the sluggish economic recovery.


On Friday, JPMorgan (JPM) reported its first-quarter earnings. They were less impressive than analysts were expecting, in part because loan growth at the nation’s largest bank in the country has evaporated. JPMorgan had $730 billion in loans a year ago. It has the same now. Deposits are still rolling in. Typically, a bank makes money lending out the money it takes in from depositors and pocketing the difference. But JPMorgan is now lending out just 57% of its deposits. It used to be more like 80% a few years ago.


Signing up borrowers was never the most profitable part of the mortgage business. The bigger profits came from collecting the interest on the loans, or selling those loans off to others. But it was never a loss leader, either.


A year ago, for instance, JPMorgan made about $750 per loan. The year before that, it booked $3,300 of profits for every new loan.


But then, about a year ago, interest rates began to rise for the first time since the financial crisis. It wasn’t much, around one percentage point, but it was enough to crater one of the few businesses for the banks that had come roaring back. And the housing market remains fragile. All of a sudden, all those people who were rushing into refinance their mortgages every time rates dropped stopped coming in.


JPMorgan funded $53 billion in mortgage loans in the first three months of 2013. That shrank to $17 billion in the first three months of this year. And JPMorgan is based on being big. The result is that you don’t just make less when you make fewer loans. You make nothing. A year ago, JPMorgan earned $500 million in the first quarter from originating home loans. In the first three months of 2014, it lost $200 million.


That might not be all that bad if JPMorgan were still making good money on the other parts of the mortgage process, like collecting interest or selling off loans. But it’s not. Interest rates are still near lows. What’s more, the rise in interest rates has squeezed the difference between what banks can charge mortgage borrowers and the interest they have to promise the purchasers of those loans. That difference a year or so ago accounted for a huge source of profits.


Put it all together and JPMorgan made just $114 million in income from its entire mortgage operations in the first quarter. That was down from nearly $700 million a year ago and $1.1 billion the quarter after that. But bankers like to talk about their businesses not in total profits but the returns they generate. Three quarters ago, JPMorgan’s mortgage business had a return on investment of 23%. Last quarter, it was 3%. JPMorgan could have almost done just as well by putting all of its money in a 10-year Treasury bond and calling it a day.


And it’s not just the mortgage business. Over the past few years, consumers and businesses – some not so great – have been able to secure loans at historically low interest rates. Expectations adjust. Now, interest rates are rising, and borrowers don’t want to pay higher prices. How long will it be before borrowers adjust? If you have just refinanced your 30-year mortgage, it might be a while.


If you want to know what higher interest rates might mean for the banks, take a look at JPMorgan’s mortgage business. It’s not good.

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Babaloo's picture

I wouldn't say the refinancing a mortgage is pointless.  It transfers cash flow from investors to borrowers, what economists would call people with a higher propensity to consume, thus stimulating the economy. 

I refinanced my mortgage and am now paying less per month, enabling me to put more money into the 401k and spend more.  Sounds like a win-win to me!

Four chan's picture

the fed created this mess with its banks in an effort to fulfill the mandate of the fed.

enslave a free people to debt and confiscate all assets through boom and bust it creates.

this is just a case of the fed and its owners biting off more than it could chew.

pods's picture

My thoughts on this refi boom after 2008 was that it allowed many banks to do a do over on the loans that had impaired collateral.
Basically the people turned in a mortgage that the bank had severed their attachment to the property and got a new one with all the paperwork done correctly.

Of course, how could one repair this with an entity that no longer had equitable interest in the property?

Big clusterfuck that should have brought down all the mortage servicers and providers.

Swept it under the rug and parked the bad ones at the FED until it blew over.


LawsofPhysics's picture

I know of at least one person who now owns his property outright after doing a title search and asking the bank one simple question; "show me the note motherfucker."

centerline's picture

Yes.  But more.

Refis are recourse loans.  In states where original money was non-recourse, the banks now have the owner by the balls.

It also allowed the secondary loan market a chance at getting cleaned up too.  No one really knows how impaired that space was - and when a property goes under the secondary has to stand in line behind the primary, in most cases meaning it is SOL.

The whole thing was a "bubble bath" to clean up the mortgage market, and stick it to the public once again.

zaphod's picture

"Swept it under the rug and parked the bad ones at the FED until it blew over."

+1, best best summary of the situation.

The new issue now however is although the FED made the private market whole, it is the government itself that is overleveraged to an unprecedented degree. The problem with that is in the next crisis it won't be possible for the government to sweep the problem under the rug until it blows over because it will be the government itself that is experiencing a funding shortfall. 

centerline's picture

Which is precisely why Western governments are hunting down capital everywhere they can.  They are going to shake us all down eventually through all sorts of nutty taxes, fees, etc.  Of course the State and local governments are going to do the same thing.

Vampyroteuthis infernalis's picture

....why the Fed was ever empowered to operate a giant random wealth generator in the first place.

It should read, "why the Fed was ever empowered to EXIST in the first place."

marathonman's picture

It ain't random, that's for damn sure.

Winston Churchill's picture

Uncle Scam thanks you in advance for your 401K contributions.

There will not be time to do so after they seize it.

One born every day.

eatthebanksters's picture

It supported home prices and kept them from dropping further...not neccessarily a good thing.  I think the deal is that our society has used debt to create growth.  Growth became dependent on more and more debt.  The big question is have we hit the wall?  Can we support more debt or is it now about diminishing returns ultimately to end up with an implosion...time will tell.  1. Consider this however, the real estate busness is huge chunck of our economy (from construction labor to labor to build the products used in home building to the architects, engineers and planners, to the real estate salepeople to the banks making the loans) and if the real estate biz is in the tank, our economy will follow.  2. The US government collected more in taxes last year than ever before in history.  3.  We have added the cost of Obamacare onto our debtload...with a slowing economy.  4. How much more can they tax us until it kills the economy.

Lastly, our president has been promising to address th job situation for 5 years...he got Obamacare, gay marriage, and he is working on immigration reform and equal pay for women, all good causes...but what about jobs and the economy?  iI haven't heard a thing since his campaign (again).

SumTing Wong's picture

Dude, if the Rs would stop railroading him from banning guns and magazines and even ammo like the 7n6 deal for the AK-74, he could create a helluva lot more jobs by keeping people from making guns and magazines and ammo. Wait, shit, I thought I had it. Nevermind. 

Ham-bone's picture

the biggest losers in this game are the holders of these very low yielding debt instruments...

SS and intragov holdings...approx $5T yielding next to nothing paid for in made up, new dollars dilluting the already huge supply of dollars - us

States/Pensions/Insurers, etc....hold approx $2.5T of US Treasury debt yielding ever less - us

Fed...holds $4T ($2.5T of Treasury debt) yielding ever less and remitting ever less back to Treasury - will transfer all loses to Treasury ( us)

Foreigners...hold $5.5T of ever lower yielding US Treasury debt paid in ever inflated dollars...that makes perfect sense???  Unless this is really just the backdoor QE via purchasing Treasury's in overseas markets??? Us???

BTW - simply look at the Japanese 10yr bond / US 10yr and see they are moving ever lower...Japanese institutions are mandated to buy by law and really so are US PD's...anyone suggesting bond rates will be rising in a revulsion to the "fundamentals" of the US or Japanese economy doesn't understand where the money to buy these comes from or who holds them...There will be another refi boom and a new cyclical low in bonds, and again, and again.  After hitting 8% in 1990, Japan's 10yr bottomed @ .5% (half of 1%) in '03 and again hit this low in '13...only real question is if Japanese 10yr will go negative (given Japanese institutions are mandated by law to buy...very conceivable).


 The US will ultimately see sub 1% 10yr yields...because what must happen to keep the game going will happen...they have the motive, the means, they have the will...so it shall be.


SumTing Wong's picture

If they keep pissing off Putin and the Chinese, the Fed is going to need a whole lot more untapering in order to make the 10yr go sub-1%...

What do you call a "market" when one entity owns everything in it???

Ham-bone's picture

Since Fed announced tapering...and reduced purchases of Treasury debt by $15B / mo...rates have fallen from in excess of 3% to 2.65%...and you can thank the Banking nations of the world (ie, Belgium's $300 B increase in US Treaury debt and Ireland's increase of $115 B...both from '09 til now...and so many more...of course these are not Belgians or Irish investors but instead CB's shuffling digits...regardless, rates will only go lower).

Likewise, check Spanish / Italian 10yr debt down from excess of 7% to 3.1% now...and Greece to 6%.  These are all centrally planned farces.  Expect more of the same.

Bill of Rights's picture

Lol you go with that son....

InjuredThales's picture

You must be a troll.

Is this million dollar bonus' next incarnatoin?

LawsofPhysics's picture

Send in the (reverse) REPO men...


same as it ever was (a relative few printing money and handing it out to their friends).


Full fiath and credit bitchez...

No more faith=no more credit motherfucker.

venturen's picture

The whole game was to take your mortgage at the bottom of the market and push the market to records and sell it back to a new set of fools. The next Generation is F$#KED!

madcows's picture

I don't know.  at some point the prices are pushed beyond what can reasonably be paid.  I call it max borrowing.  I think we're about there now.  They can print until the interest rate is 0, but if Johnny Main St. doesn't have a job he can't buy the overpriced house or education or health insurance.  The collapse is inevitable, it's just a question of when.  I say next year.

Four chan's picture

just let all of us not forget the fed created this destruction of america.

the fault lies on its true creators/owners shoulders.

scraping_by's picture

It also works that way if Johnny Main St. get paid just enough to keep from starving, mostly. All those convenience store clerks and burger flippers are making pocket money at best. Wal-Mart employees aren't going to get off public assistance soon, which works out to a negative wage.

The old advice was to live poor to become rich. Now it's just live poor.


Quinvarius's picture

Short term and midterm the stock markets are entirely speculation, leverage, and hot money.  I think I have seen enough stupidity in my life to say that stock prices are set that way.  And maybe I would not have identified this as a bubble if it had not sucked the cash out of gold, as it did in the late 90's.  It might even be sucking the life out of the public Mortgage market too.   But clearly, all the leverage and cash is going to the same trade right now.  I don't like the way it looks.   

intric8's picture

For the TL;DR peeps,
Banks are having a hard time making money once again, WE ARE DOOMED

chinoslims's picture

It's okay.  The US government will save them again.  The banks are like Ukraine; they are too big to fail.

With the magic printing press, you can play god and save and condemn whoever you want.  I am not one of the chosen ones.

madcows's picture

Refi's are just another way for them to make money.  Charge the poor borrower another 3-5K to lower their rate.... AND, in addition to getting more money up front, they still make money on the interest.  It's all about the money changers making more money.

In other retarded epiphanies, the realtors know what the buyer can afford each month and just takes the low interest rate loan as an opportunity to raise the asking price.

Hey FED, go fuck yourself, your greed has destroyed the world's greatest economy.

Schmuck Raker's picture

No biggie.... Jamie Dimon is still richer than me.

kchrisc's picture

"First, why does the monetary politburo think that a zero-sum shuffling of shoe purchases into the spring of 2012 and out of 2014 makes any sense?"

The banksters needed to shift cash for themselves, from origination fees, into today from the future, old loan, to prop up their criminal asses.

"A bankster would never sell his mother. He'd loan her out for the cash stream."

kw2012's picture

It was all about buying time to fix fundamental problems.


They bought time, but didn't fix the problems.


The result? with such a massive spreadsheet they are much less able to handle the next crisis which will occur because none of the problems were fixed.

TideFighter's picture

Restarting the amortization schedule is a con not likely picked up by most 'Merikans. just sayin'

SmilinJoeFizzion's picture

Agree-- only way to roll a refi is to go from 30yr to 15 or less. 

scubapro's picture


the qe is starting to backfire.   low rates have helped drive up home prices, high home prices mean fewer can qualify  to buy due to  stagnant incomes.   fewer buyers means less mbs for the fed to monetize.   a 'not as bad as recent years'  federal deficit means fewer tsys for the fed to monetize.   

the fed already owns/controls a large portion of the tsy and mbs markets.  it knows this is not sustainable or good for the global financial system as US tsy are the collateral for everything.     they need more asset to buy, but only buy assets backed by the tax payers, tsy and msb's.  

the next short term solution will be directed at those 25mm underwater mortgagees.   they will update harp to allow all the surviving alt-a and other underwater mortgages be refi'd and guaranteed by freddie and fannie.   THEN they can untaper and either save the stock market one last time, or drive it to new highs.

scraping_by's picture

One minor quibble with Mr. Stockman's analysis. He imagines the bankers puffing the weed, watching the money go out with a Rastafarian wave of the hand while saying "Jah love, mon."

It's more the paranoid self-aggrandizement common in long term use of stimulants like meth, cocaine, and amphetamines. Which is a good analogy for their financial policy.

To quote Hunter S Thompson, "You can turn your back on a person, but never turn your back on a drug." Whether it's crack or QE, you can be sure there will come a crash and it's going to be ugly.

marathonman's picture

Maybe there will be a crash.  Maybe not.  I've been astonished that the Ponzi scheme has lasted this long.  Ponzi's can stay irrational longer than I can stay solvent.

Augustus's picture

"By resorting to this maneuver to leave more money in the pocket of borrowers each month, our monetary central planners undoubtedly hoped that America’s flagging consumers would buy another flat screen TV, dinner at Red Lobster or new pair of shoes."


Those TVs, shoes, and lobster dinners may have been purchased by the savers and lenders.  Only real change in overall economy was to insure food for the leaches collecting the fees.