Change in Mortgage Industry

Posted on December 16, 2019 by Nancy Liu | Category: Real Estate

Mortgage Industry Face Significant Change

Over the past four years, while the housing industry is booming, an explosion of exotic mortgage underwriting dominated the market, fueling outsized profits and excess leverage for borrowers, banks and Wall Street debt underwriters.  With the subprime crisis and ever deepening downturn of housing market, the whole mortgage industry suffers big losses.  For example, the number one mortgage company, Countrywide posted a $1.2 billion loss for the third quarter, or $2.85 a share, sending its stock down 30% that day.  Washington Mutual has seen its profits wane as well, and announced plans to cut its dividend by more than half while it attempts to raise capital in the market for convertible preferred shares.  As a result, the whole mortgage industry is facing tremendous challenge.  It is obvious that the mortgage industry will not ever again be the way it was in the last four years and the businesses that relied on mortgage lending will have to shrink down and expect to make less money going forward.

Historically, 80% of mortgages originated in the U.S. were conforming to Fannie Mae (FNM) and Freddie Mac (FRE) underwriting standards, meaning that these government-sponsored entities were able to guarantee the loan. In recent years, that ratio dropped to just 35% of mortgages were conforming, as more esoteric mortgages gained dominance in the wake of historically low 1% interest rates set by the Federal Reserve in 2003. Some experts predicts that the mortgage industry will contract for four to six years before the glut of homes is worked off.  It is reported that New-home sales at the end of October were about half of what they were at the peak of the housing boom in June 2005. The inventory of new homes hit a 17-year high in August. Existing-home sales are down 26% from February, and as of October, the inventory glut reached a 10.8 month supply, a multidecade high.  While in extreme cases, some economists believe home prices will fall another 35% to 50% to go back to historic norm, it is commonly agreed that home prices can easily fall down another 15% to 20% before the housing market stabilizes.

In the effort to stabilize the housing market, on one side, the Fed has cut interest rate several times last year to lower the borrowing cost and has taken unorthodox steps to improve liquidity and bring down key interest rates that impact mortgage resets and corporate funding rates. On the other side, the Fed has coming with new measure to get rid of the abusive leading practices that were prevalent in the past few years. In a newly passed regulation, the Fed (1) forces lenders to make sure that subprime borrowers set aside money to pay for taxes and insurance; (2) bars lenders from making loans when they don’t have proof of a borrower’s income; (3) prohibits lenders from engaging in a pattern or practice of lending without considering a borrower’s ability to repay a home loan from sources other than the home’s value.

While those measures will certainly bring pains to the current mortgage industry, some experts say that the current crisis is not unique to past mortgage industry woes of prior decades, which did nothing to stem the resurgence of nonconforming lending once the excess was washed out. The most recent example was a wave of subprime lending that wound down in the flight-to-quality panic of 1998 after the hedge fund Long Term Capital Management decided to liquidate its assets. Other cases in mind are the boom of second-mortgage lending in the 1980s, as well as scandals throughout the years surrounding lenders practicing discrimination against borrowers in immigrant or low-income neighborhoods.

Because of the big scale of the current housing downturn, the US government may be forced to take more drastic measures in the near future to bring confidence and liquidity back to the Mortgage Industry that has been severely battered.

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