Linkages Between Secondary and Primary Markets for Mortgages

Abstract

The author analyzes the role of the retained portfolio investments of the government-sponsored enterprises, FNMA and FHLMC. The retained portfolio is shown to be a powerful instrument to influence yield spreads in the secondary and primary markets for mortgages. The long-run investment function links mortgage yields to the volume of their portfolio investments, guaranteeing that the spread cannot diverge indefinitely. A one basis point increase in the spread is estimated to produce an infusion of $554 million in the secondary market. When there is a deviation from long-run equilibrium investment levels, short- run dynamics (changes in purchases and spread) are set in motion to correct the disequilibrium. These benefits are passed directly to the homeowner. There is a one-to-one transmission mechanism; a reduction of one 1 bp in the secondary market spread reduces the primary market spread by 1 bp, rendering these markets efficient.