Mortgage Demand Collapsing

[mjkst27]

IDS quote today from Doc:

 

"I occurs to me that with mortgage demand collapsing, how can the GSE's be so radically expanding their portfolios. Something's wrong there. Not for discussion here. Please open a discusiion on LOB if interested.. "

 

 

Doc - what difference does it make? The GSE's can just buy agency MBS off the open market, from institutions and banks and MMF's and whoever. The MBS birds flying home for the summer so to speak. Anything to continually reaffirm the market price of an MBS at 40bps over treasuries. Then the MMF's just buy more agency paper themselves with the money they got for selling the other MBS to the GSE. What a bunch of mBS - its a circular vortex particle accelerator like wyndy calls it. Isn't this what Noland was talking about last week? BTW Did you ever drop Doug a line?

 

This whole thing is confusing as shit, but I guess it all just boils down to the fact that with the yield curve at absolute low levels all the way across, yield chasing dictates that there be much artificial demand for securities that otherwise would not deserve it. In other words, this is the hand of Fed interest rate cuts at work - forcing the market to demand endless quantities of agency paper, which oh by the way can be created with no limit by the GSE's. A beautiful circle jerk.

[Hiding Bear]

Think you got this right.

 

The only weak link in the "circle jerk" is the willingness of MMFs and other investors to continually purchase more and more GSE securities. So far, these groups have not been discouraged by moves in Congress to completely remove all formal links to the GSEs.

 

However there is another vunerability here that is not readily apparent. Money balances at MMFs are being drawn down to sustain spending and, to a lesser extent, to provide new funds to the market. The grand experiment of the Fed to shift money from savings to the market may untimately be counter-productive. Less money in the economy means the economy slows down - and also GSEs have a tougher time bailing themselves out (as described by Noland).

[mjkst27]

Here's Doug Noland's explanation of the mechanics of the MMF/Bank complex and how it defeats all notions of "reserves" - and can thus create liquidity at will with no limit. I believe he also describes the MMF symbiosis with the GSE's in this piece as well. BEWARE this is heavy duty stuff. Skip down to the paragraph that begins "We are going to dive, once again, into the gritty nuts and bolts of money and Credit creation...." and begin there.

 

Doug Noland 2/15/2002

[Guest sigmoidoscope]

US Mortgage Market - Colossus In a World of Its Own

 

Not a new article, but an interesting insight from a mortage company web site.

 

 

US Mortgage Market: Colossus in a World of Its Own

Hubris 'R' Us

 

The US mortgage market is confusing, incredibly productive and fundamental to understanding the nation's banking industry. It is the economic engine that drives the retail banking market, yet is composed of so many disparate parts that it defies easy categorisation. Charles Davis reports

 

IN A troubled US economy, it is mortgage lending that continues to provide a ray of hope. Spurred by rock-bottom interest rates, lenders have been flooded with a record number of mortgage applications from homeowners eager to refinance existing loans. Average interest rates - excluding origination fees - on 30-year and 15-year home loans have sunk to record lows of 5.84 percent and 5.20 percent, respectively.

 

Thanks to the huge market for mortgage loans, the US has one of the highest percentage of home ownership of any major economy - 68 percent of households. The industry, on track to post its best-ever year, is expected to make .2 trillion of home loans in 2002, according to Fannie Mae. "There's more demand in the mortgage system," said Mary Lou Christy, vice president of investor relations at Fannie Mae. "These rates are driving homeowners toward us in record numbers."

 

Wells Fargo Home Mortgage, the number one mortgage lender, had lent more than 4 billion in home loans by mid-September, surpassing the record amount issued for 2001, said Doreen Woo Ho, president of Wells Fargo's Consumer Credit Group.

 

The US housing market has been a pillar in an otherwise shaky economic recovery, although a small but growing chorus of anal cysts has been cautioning that the mortgage industry cannot continue to lift the entire economy if other key sectors like stocks and manufacturing do not kick up to a higher gear.

 

Home equity loans fuel the economy

 

"While housing prices continued to surge, homeowners' equity ticked downward in relation to the value of household real estate, suggesting that the growing number of families who use their home as their principal form of savings may be caught short if the housing boom winds down abruptly,'' the Financial Markets Center, a financial research group, said in a recent report.

 

Homeowners' equity as a percentage of household real estate had dropped below 57 percent in the second quarter, the group said. It is likely to decline further, as home equity borrowing hit 4 billion in the first half, around 10 percent of all mortgage lending, eclipsing the previous high of billion in 2000.

 

All of this raises the question of how a single industry can prop up the entire US economy at such a fragile moment in history. The answer lies, at least in part, in the structure of the US mortgage industry itself: part competition, part regulation and part government intervention.

 

The simplest way to explain the US mortgage market is to point out its many differences when compared with other countries. Its standard mortgage is a 15-year or 30-year fixed-rate note, funded through Fannie Mae or Freddie Mac, the two government-sponsored organisations that provide funding lines to introducers of private mortgage businesses (see box on page 9). The industry grumbles at times about the influence of these government-backed behemoths in an otherwise private industry, but even the harshest critics must admit that the infusion of government money oils the entire machine.

 

Sub-prime borrowers welcome

 

Unlike European mortgage markets, non-conforming and sub-prime lenders take their place at the heart of the US mortgage industry, alongside prime lenders. Blocks of mortgage finance funding are offered to the market as an investment opportunity. This is something already mirrored in the UK and across the EU, with the increasing trend towards securitisation, led by the sub-prime and non-conforming sector, but now taken up by some prime high-street lenders.

 

The biggest difference - and the key to the diversity and strength of the US mortgage market - is that in the US, mortgages and all their related services are treated as commodities, with different aspects of the service broken down and specialised.

 

In the purest mortgage transaction, a bank customer walks into the branch, announces the need for a home loan, is approved for a loan, finds a house, has it appraised and buys the home with the bank's funds, then gradually repays the bank. Seldom, however, is this the case, largely because the mortgage business is so competitive.

 

Instead, mortgage bankers - also known as originators - provide the original funds for mortgage loans, but typically never see the retail customer, who instead hires a mortgage broker to handle all the paperwork and shop around to find the lender with the best rate. The originator then typically passes the servicing of the loan to a specialist. If foreclosure becomes a possibility, it is passed on again, and perhaps again.

 

For most homeowners, then, the monthly mortgage payments include three separate parts: a repayment of principal, an interest payment, and payments into a special account (called an escrow account) that the lender maintains to cover costs such as hazard insurance and property taxes. These elements are called PITI (Principal-Interest-Taxes- Insurance).

 

Traditionally, buyers have made a down-payment of 20 percent of the property cost, but in the past decade or so that has changed considerably, with a flotilla of loans requiring only 3 or 5 percent deposit, and even loans that require no down-payment.

 

Huge role of the secondary market

 

Then the mortgage banker usually sells that mortgage in the secondary mortgage market to lenders such as Freddie Mac, releasing the money to lend again. Originators usually continue to service the mortgage, so borrowers often do not know their mortgage has been sold. Mortgages can be bought and sold dozens of times. (The author's most recent mortgage is 3 years old; it has been sold three times.)

 

The secondary mortgage market's importance cannot be overstated, and not everything about the current refinancing boom is rosy news. Mortgage loans, which are bundled and traded as debt securities, now make up nearly 40 percent of the bond market, dwarfing even US Treasuries. To banks, insurers and pension funds, they offer long, predictable payment streams over the life of the mortgages - typically 30 years. Fannie Mae and Freddie Mac are big investors, too.

 

When falling rates lead to a wave of refinancing, institutions rush to replace the income from retired mortgages by buying, say, US Treasuries or other bonds, which will continue to pay. If they do not act quickly, their portfolios could sink even lower. The problem is that this buying drives up bond prices and pushes down yields, which in turn pushes mortgage rates down even further - triggering more refinancing.

 

Thus bond-market volatility - measured by the fluctuation between daily highs and lows - is at its highest since 1987, says market anal cyst James Bianco of Bianco Research. Daily swings for 10-year Treasuries were even wider during the past 12 months than in 1998, and during 1994's interest-rate surge.

 

Such volatility is important, because it raises transaction costs for corporations and investors going to the market. Sellers have to take lower prices; buyers pay higher prices than they otherwise would. A larger concern is the increased chance that a big institution will suffer crippling losses if, in these wild markets, rates move more than their models predict.

 

Slick, standardised, transparent products

 

Another key distinction is the speed built in to every point in the system. Applications, appraisal valuations, underwriting and insurance requirements are standardised across the industry, driven by the need to qualify for loan guarantees. Every buyer and seller of real estate in the US market fills out the same forms. If an application meets the essential criteria, it will almost certainly be granted; if a loan is denied, the reasons must be detailed by a form letter universal to mortgage banking.

 

With all of the major players in the mortgage system enabled for e- commerce, a mortgage request can be completed in a matter of days - and examples exist of homes bought and sold in a single weekend.

 

Transparency also is built into the system, as demanded by federal law. Perhaps the most impressive example of this is the requirement that borrowers are issued with a detailed chart illustrating all of the costs associated with taking out a proposed mortgage, within 3 days of making an application.

 

This form lists everything from the initial deposit, origination and insurance fees, to an outline of the borrowing rate, monthly payments and the total cost of credit. In other words, the full price of transacting the mortgage, from start to finish.

 

The industry is populated by many of the dominant names in retail banking, but also by several large specialists that have specialised in mortgage banking, and by thousands of local institutions.

 

Mortgage lending is, like credit cards, a business with considerable economies of scale. Rather than outsource mortgage servicing and keep the loans on their books, most banks sell them on the secondary market; other banks buy on the secondary market. The industry was so fragmented 20 years ago, and even 10 years ago, that while consolidation has been dramatic (see Table 3), tens of thousands of originators and servicers are still active in the market.

 

Dominant players include Wells, Washington Mutual, Chase Mortgage, Countrywide Home Loans and Citi (see Table 4), although virtually every major bank and thrift is still participating in the market.

 

Predatory lenders drive delinquency

 

If there is a downside to US mortgage lending, it could be the predatory practices of some lenders in the anything-goes market of 2002. Mortgage brokers have been caught padding applications with numbers acceptable to a lender, whether accurate or not. Increasingly, brokers make loans themselves - which they sell to banks that, in turn, package and sell them as mortgage-backed securities.

 

Consumer advocates and mortgage experts say the real drivers of fraud are a small band of industry pros. One of the fastest-growing scams, for example, is filing loan applications using identities of dead people from obituaries and genealogy websites.

 

Yet problems also exist at the macroeconomic level. In their eagerness to lend, banks have pushed too many people to take on too much debt. Both Citibank and Household have been forced to pay fines and compensation of hundreds of millions of dollars for predatory mortgage lending to the sub-prime sector (see story on page 1).

 

Sub-prime borrowers are extremely vulnerable to higher interest rates and rising unemployment. That raises the prospect of a flood of defaults. And a wave of distressed properties would have major implications for the housing market - one of the few areas of the economy that is thriving.

 

Loan delinquencies have steadily risen in the past 24 months, to the point where nearly 5 percent of loans are delinquent - one of the highest rates in the past decade. A record number of loans are in foreclosure - and that is not even counting "sub-prime" loans to people with bad credit, according to the Mortgage Bankers Association, which has urged caution of late.

 

Banks, however, continue to promote "125 percent mortgages" that let people borrow the full price of their house plus extra cash to pay for a vacation, college tuition, or anything else. The process has become so automated that a borrower can get pre-approval in 5 minutes or less on some websites.

 

Borrowers can apply for a loan through eloan.com, a portal backed by legitimate banks such as Wells Fargo & Co. that abide by fair lending practices. But there are plenty of websites that pitch pre-approvals to people with bad credit. Many, say experts, are backed by unscrupulous mortgage brokers or lenders.

 

Warts aside, it is hard to dispute the over-all power of the US mortgage industry. Housing affordability is near a 20-year high (meaning that houses are quite affordable, despite the rise in prices). Also, income of the median homebuyer is now 32.5 percent above that required to finance the purchase of a median-priced house.

 

 

TABLE 4: TOP ORIGINATORS OF GUARANTEED MORTGAGES, FIRST-QUARTER 2002

 

 

1 Washington Mutual 32.6

2 Countrywide Home Loans 25.5

3 JP Morgan Chase 13.0

4 GMAC Mortgage 7.3

5 Flagstar Bank 6.0

6 CitiMortgage 5.5

7 First Horizon 3.4

8 Ohio Savings Bank 3.0

9 First Nationwide 3.0

10 Charter One Bank 2.8

Total for top ten 102.1

 

Freddie Mac

 

1 Wells Fargo 38.0

2 ABN Amro 23.0

3 National City 6.5

4 Bank of America 6.4

5 JP Morgan Chase 5.0

6 Principal Residential 4.7

7 Sun Trust Mortgage 4.0

8 US Bank 3.8

9 Countrywide Home Loans 3.0

10 BB&T Mortgage 2.5

Total for top ten 96.9

 

Source: Fannie Mae