When we “fix” something that’s broken, there’s a natural tendency in all of us to think, “Great, that nightmare’s over and it’s finished…I don’t have to think about that ever again,” right?
That’s what happened with the financial crisis 10 years ago. Thousands and thousands of people lost their homes, their jobs, their savings…and then it was over. Or so “they” said. We don’t have to think about that ever happening again because “they” fixed it.
Not so fast. Regulators have, in fact, done quite a lot to reform the financial system but…guess what? Subprime mortgages are back dressed up in a new name…nonprime mortgages…and the core of the problem, the US Mortgage market, has not been fixed.
Just to refresh your memory regarding the financial/housing mess we all experienced 10 years ago, loosely regulated companies, many of them private label mortgage companies that were not guaranteed by the government, doled out and financed mortgages with unstable short-term debt to borrowers without solid employment, savings, or credit and BAM, chaos reigned when borrowers began defaulting on their mortgage payments. Nonbank mortgage lenders imploded. Loan servicers left borrowers stranded. Banks lost and were fined billions of dollars.
Congress and regulators stepped in and created new rules to eliminate the worst of the pre-loan products. Higher capital requirements were put into place to make banks somewhat more responsible and resilient. But, much was left undone.
What’s happening now is that highly regulated entities such as the Bank of America (just one of the banks fined billions of dollars for its pre-crisis bad lending practices), have totally shied away for the mortgage business. Instead, they offer short-term credit to nonbanks such as Quicken Loans (known as Rocket Loans, the FHA’s insurance program’s largest participant and neck-and-neck the largest retail mortgage lender in the country with loan origination of nearly $100B, and Penny Mac.
These nonbanks now own +60% of new mortgages in the country…a huge jump from the 30% they owned in 2013. The good news…nonbanks supply mortgage credit to borrowers when there might be none. The bad news…nonbanks are lightly regulated and are undercapitalized. In a crisis, banks that loan nonbanks more such as Bank of America could pull these nonbank lenders’ credit lines and leave taxpayers holding the bag on bad loans and/or defaults.
When it comes to servicing these loans, the same problem exists. Nonbanks, such as Nationstar and Ocuven, now handle one third of all outstanding mortgages. In a crisis, could these nonbank servicers cope? At the end of 2017, three of the largest publicly traded nonbank servicers had less than $4B in tangible equity and more than $6B in servicing rights. Pretty precarious, don’t you think?
The story is the same when it comes to the private securitization market. Last year, the US Treasury Department and the Structured Finance Industry Group, a trade association, recommended ways to help balance the demands of lenders, packagers and investors…but nothing has happened in terms of acting upon those recommendations.
What can be done to really “fix” our still broken US mortgage market? Regulators need to put banks and nonbanks (lenders, servicers, private securitization markets) on equal footing. Equal footing translates into real rules and penalties concerning the legal responsibility for bad loans, higher capital/liquidity requirements, more across-the-board standardization, and governance/enforcement authority.
Additionally, “fixing” our mortgage market would be a precondition for solidifying our government loan instruments, Freddie Mac and Fannie Mae, as well.
