Borrowers irked as banks rake it in

Shannon Luhrsen, a stay-at-home mom in Wilmington, N.C., can't understand why she should pay 5.8 percent for her mortgage when her local bank gets money from the Federal Reserve at little more than 0 percent and the U.S. government is borrowing for 10 years at 2.6 percent.

"I want to get in the 4's," Luhrsen said. "That would be fantastic. I don't want the bank to have my money. I want to have my money."

The last time the disparity between 30-year mortgage rates and 10-year Treasury yields was so great during a period of Fed monetary-policy loosening was 1982, when Timothy Geithner entered his senior year at Dartmouth College and Fed Chairman Ben Bernanke was an assistant professor at Stanford University.

Until Geithner, President Obama's Treasury secretary, and Bernanke figure out a way to narrow the spread, the economy will be in "quicksand," said Clyde Prestowitz Jr., president of the Economic Strategy Institute in Washington, D.C., and a counselor to the secretary of commerce during the Reagan administration.

"We can't stabilize the overall economy until we fix housing prices, and mortgage rates are a huge, if not the biggest part of that," Prestowitz said.

Rep. Maxine Waters, D-Calif., and the No. 3-ranked Democrat on the House Banking Committee, also wants banks to lower mortgage expenses.

"If the government is making sure that cost is dropping for the banks, it should be dropping just as much for consumers, but they're not," Waters said. "Banks could make loans at 4.5 percent, or even lower, and it would still be profitable."

Even though the average 30-year fixed-mortgage rate fell below 5 percent last month for the first time since McLean, Va.-based Freddie Mac started keeping records in 1971, the banks' profit margins are increasing.

That's because the yield spread between 30-year mortgages and 10-year Treasury notes is 2.5 percentage points, compared with an average 1.7 points during the past two decades, data compiled by Freddie Mac and Bloomberg show. The difference on Dec. 3 was 3.3 percent — the widest since 1986, when the Tax Reform Act eliminated real-estate-related tax shelters.

Efforts by Bernanke to reverse the two-year drop in home prices and the economic slump depend, in large part, on banks lowering rates enough to stimulate loan demand. His attempts are so far having little effect.

Analysts estimate the economy will contract 1.5 percent in 2009, a half percentage point more than projected a month ago, according to a survey compiled by Bloomberg.

JPMorgan Chase, the largest U.S. bank by market value, and Bank of America, the country's biggest home lender, said the industry is changing the terms of existing mortgages to keep Americans in their homes as job losses spread across the nation.

Jamie Dimon, JPMorgan's chief executive, said in a Jan. 15 statement that the company has prevented more than 300,000 foreclosures, and "we plan to help more than 300,000 more families keep their homes through mortgage modifications over the next two years."

Bank of America will adjust more than $100 billion of existing home loans to keep as many as 630,000 borrowers from defaulting over the next three years, CEO Kenneth Lewis said in a Jan. 16 conference call after the company reported a fourth-quarter loss of $1.79 billion.

In the current business climate, "rates should be 4 percent, not 5 percent," said Lawrence Yun, chief economist of the National Association of Realtors, a lobbying group in Washington, D.C.

Spreads are even wider for adjustable-rate mortgages. The average 1-year ARM is almost 5.8 percentage points above three-month Treasury bill yields, the biggest gap ever, and far above the historical average of about 2 percentage points, according to Bloomberg data.

The difference peaked at 6.9 percentage points on Sept. 16, after the bankruptcy of New York-based investment bank Lehman Brothers Holdings.

The increase in costs runs contrary to programs supported by Obama, who said in speeches during the past month that "we've got to start helping homeowners in a serious way."

Financial institutions have reduced risk-taking after more than $1 trillion of write-downs and credit-market losses since 2007, triggered by record subprime home-loan defaults in the U.S., data compiled by Bloomberg show.

Banks are so traumatized by their losses that they're reluctant to narrow lending spreads or extend loans, said Douglas Duncan, chief economist at Fannie Mae, the D.C.-based mortgage buyer seized with Freddie Mac in September after federal regulators determined the companies were at risk of failing.

"Underwriting criteria have been tightened considerably, and that is a real issue," Duncan said.

"Mortgages could well be close to 4 percent if they reflected traditional spreads. It's not greed or things like that. It's the real risks the banks see."

Luhrsen and her husband, Mike, a 42-year-old airline pilot, said they worked hard to buy their three-bedroom ranch house with a boat pier. Now they see their ability to retire and pay for college slipping away.

"I'm very frightened about the economy," she said. "We worked very hard for what we have, and we're afraid it's being taken away from us."