12/20/2012 01:12 pm ET

What Banks Won't Tell You About Their Sweetheart Deal With the Fed

The beauty of supply-side economics, is that just when you start to believe that it might actually be theoretically true, there's always reality that breaks that fantasy.

Supply-side economics (in case you've forgotten), is an expression of marco-economics that is synonymous with Reaganomics and trickle-down economics.

The latest manifestation of this theory should be applicable to the Fed's recent action this past month in reducing its lending rate to banks. As a result of the Fed buying $40 billion a month in mortgages, interest rates have trickled substantially downward, and consequently, the major banks (i.e., JPMorgan, BofA, Wells Fargo), have increased their profit margin substantially on the money they lend to consumers who are buying a home or refinancing their property.

However, the banks somehow forgot to trickle down the savings to "those" that keep them in the profitable, mortgage lending syndicate promulgated by the American banking industry. And just who are "those." The people, of course. Which I can image is what Karl Marx might say today if he had ever had a bank account. Which on a historically note, he never had. He died broke. (I digress).

Cry Me A River

And the reasons given by some of the 800-pound gorilla banks:

"If we lowered the rates too substantially, our call centers would be flooded with phone calls."

Or, "If we lowered the rates proportionally to the deal we're getting from the Fed, we might run askew of stricter federal guidelines that require us to be more prudent when lending."

And lastly, as stated by Timothy Sloan, CFO at Wells Fargo, lowering prices would not be "a good decision from a profit standpoint." (No shit Sherlock!)

With honesty like that, who needs banksters? Transparency delivered to your front door with an extra quarter point add-on to your rate. Or to quote another 800-pound gorilla, the CFO of JPMorgan, Doug Braunstein noted: "We're not going to price a lot lower to create demand. ... These are competitive businesses, and we have to compete."

Free Markets?

With the latter abject half-truth falsehoods, it is important to recall the truism --- or head fake, depending upon your political perspective, that when you let free markets work, the consumer benefits!

Do not be fooled. According to Paul Miller, an analyst with FBR Capital Markets and a former bank examiner with the Federal Reserve Bank in Philadelphia, "Banks are in the business of making money and are not going to cut their profit margins for the social good."

As an erstwhile real estate professional who has worked in mortgage operations facilities in over a dozen different states, in about two dozen cities, I can somewhat vouch for the comment regarding a banks' vulnerability to supply and demand issues. To be clear, sudden mortgage spikes make it exceedingly difficult to properly and efficiently respond to stratospheric mortgage demand.

When an interest rate spigot is let loose, pipelines back up, loans are improperly underwritten and mistakes pileup. This is nether good for the consumer nor the bank. Hence, elasticity can become poisonous to the mortgage loan experience and nobody is happy.

The upside in this profitability conundrum that the mega billion banks find themselves in these days, is that the mid-size players in the mortgage lending industry -- who borrow at the same rate as their big brothers, will be able to offer the same loan product for a quarter to half a point lower; which if a consumer is smart, will shop their business to these lenders to save an extra few hundred dollars a month on their mortgage payment. Although this is good news for astute consumers, trickle-down economics does not work when water does not flow to the low point of gravity.