US Mortgage Lenders Are Starting to Go Broke
bloomberg.com
bloomberg.com
This is the consensus view. Funny thing is, this is exactly the kind of thing people were yammering on about with respect to "subprime" in 2007. Contained. Don't worry about it. A few weak players will go under, but there is no systemic risk.
Now, maybe that's true this time. Or not. What is certain is that the mortgage industry went through a metamorphosis since the GFC, and most of the players are now not banks.
> “The nonbanks are poorly capitalized,” said Nancy Wallace, chair of the real estate group at Berkeley Haas, the business school at University of California, Berkeley. “When the mortgage market tanks they are in trouble.”
> In 2004, only about a third of the top 20 lenders for refinancings were independent firms. Last year, two-thirds of the top 20 were non-bank lenders, according to LendingPatterns.com, which analyzes the industry for mortgage lenders. Since 2016, banks have seen their share of the market shrink to about a third from about half, according to news and data provider Inside Mortgage Finance.
So what happens when the major source of debt fueling the ongoing housing debacle comes from "poorly capitalized" non-banks? The obvious answer is that the gravy train careens into a ditch. Less capital means fewer loans. Fewer loans mean house prices are no longer supported by debt. Given that they stopped being supported by incomes a long time ago, there's nothing left to prop the thing up.
So it will certainly be different this time around. Every financial crisis is different in its own way.
But financial crisis are rare despite all the media attention they get. Just two major crisis in the past 100 years: 1929 and 2008. There were some smaller ones but nothing compared to those two. So it's more probable that this too will not become a full-blown crisis.
29 was huge (way bigger than 08), but many of those others were in the ballpark of 08 or larger. As far as I'm aware, it's unlikely we'll ever see another as large as 29, but 08 sized? I'd expect another within 30-50 years of it.
From where I was standing, 08 was a setback.
How large of a mortgage you can take is directly supported by your income. Certainly, debt lets people can afford more with less, but the income supports the debt, which supports the housing prices.
My current reading is that the "consensus" wasn't wrong per se, just maybe naive? So far as I can tell, "true" inflation was minor and relatively transitory. What wasn't is problems like collusion amongst a small handful of market owners and other consequences of extreme consolidation like one factory for formula going down erasing 40% of formula production over night.
That's my take right now at least.
As anecdata, I was looking at a mortgage in SF recently (didn’t end up with one) and non-bank lenders offered me 2-3X the debt that a bank would offer, including rocket mortgage, which told me I could take out debt where the monthly payment was ~100% of my post-tax income (and 5% down). This was with no co-signer. I do have strong income and income growth potential (SWE in SF) but yikes I laughed at the guy on the phone when he told me the numbers because it was unreal.
Anyways I don’t have a mortgage and I really hope the availability debt to people absolutely crashes and takes housing prices with it.
In 2008 the fundamental problem were defaults - people just weren't meeting their mortgage payments (and lots of financial engineering that spread the losses in ways nobody understood beforehand). This sounds like the problem is mainly related to rising interest rates, through a number of channels: 1) less demand for loans and thus less top-line revenue, 2) lower value of fixed-rate loans in wholesale markets (on which they seem to have relied), and potentially 3) higher refinancing costs if they didn't hedge out the interest rate risk in their books (fixed interest income, floating interest expenses). Banks generally hedge out these risks because regulation forces them to be very conservative in their risk management, but here it seems we're mostly talking about non-banks, so they may have fallen for the temptation of a little short-term profitability boost by saving on interest rate protection.
I'm not saying that defaults aren't a problem, especially in this extremely high-risk subprime business that we seem to be talking about here, but there is some hope to think that those might be less bad this time. We're seeing a lot of inflation, and if wages keep pace with prices (conceivable in a time of low unemployment) then the burden of debt service on fixed-rate mortgages would actually become smaller in proportion to the overall household budget. Of course, there are still a lot of ways things could go quite wrong re defaults (eg prices have been skyrocketing in a lot of areas, if those start to plunge anything is on the table, even strategic defaults). But it's interesting to note that lenders can also face problems unrelated to defaults.
I'm also curious how those actors (usually insurances) who took the floating end of interest rate swaps during the lows are doing now.
The big difference is that the underlying loans are still money-good, they’re just paying a low rate of interest.
-rip
However, I think this time is as you say, a bit different, but we'll see.
If you have the typical FHA, VA, conventional mortgage not much has changed for you.
Now I don't think we're about to see the black swan again. But its always the riskier-end of the market that reacts first. I think its important to keep an eye on the subprime / risky mortgages to get a feel on the market.
The current question is "demand destruction", from a combination of inflation and rising interest rates. If the real economy out there is truly getting worse, then these little issues will become more and more common.
Since the banks can't use those federal services (Fannie Mae) they have to carry that risk.
Here's the loan limit map for 2022: https://www.fhfa.gov/DataTools/Tools/Pages/Conforming-Loan-L... It's more than just three cities, including all of northern Virginia, and there's gradations.
What the OG poster misses is that their income is now a local income - so local incomes also rise.
Then the mortgage is quickly sold off, the money recouped, so they can go and originate another mortgage.
At any given time, they hold a very small fraction of all the mortgages they might originate in a years (in this example $10B at year).
It seems very strange, and terrible for borrowers, that you can form a contract with one entity, and then have it transferred to another without your agreement. From what i've heard, those transfers aren't purely formalities either, people get hit with weird charges sometimes.
This describes the US system as well. The 'servicing' (who you pay each month) of the loan might change hands, but the underlying debt was bundled and sold off already. In the US, many banks don't service loans. I assume, that "Fund X" buys the securities using funds from 401ks, etc, and they kick the servicing to a preferred partner. The partner gets paid some cut. The fund gets the yield, the fees are paid out to to the servicing entity.
This is why the 2008 event was so disruptive. Mortgage brokers were labeling everything as AAA, and the funds were buying them up. Banks weren't risking their own capital, they want the 401k holders to own the debt, and they just take their cut. It's a nice racket, can't figure out how to break in, though.
It's an incredibly tightly regulated system, and the buyer of the debt is still subject to the exact same contractual obligations that the originator had.
You're basically asking, why do retail stores exist? Why don't people go shop directly from the central distribution warehouse?
Exactly. Retail stores basically don't exist (or are in a clear downward trend) for the same reasons. People realizing they don't add value and they can just buy their stuff directly.
It's the same here, how does quicken loans add value? They do something the people they sell the loan to can't? Not really, it's just marketing. Quicken loans has built a marketing funnel, they get the loans, then sell them. The value they add is marketing.
It is possible to find mortgage loans that are not resold, but you may pay for the privilege (or get a 10 year loan, those are short enough that they're often not worth reselling).
The first offered bi-weekly payments, the second didn't. So you aren't even guaranteed the same "features".
Labour intensive, though. Packaging up many loans and selling it as a complete unit is far easier.
You could find financing for 50 to 100k, especially if you have a 300k house as collateral as part of it.
Only the other bank gets the sweetheart deal.
Same kind of problem with foreclosure auctions too btw. They require cash up front for those, you cant put a mortgage on a foreclosed house. (without it first being bought outright by the bank, who isnt gonna mortgage it to you for the foreclosed price)
Further, in most times MBSes are usually worth more than the debt - otherwise, modern banking wouldn't make any sense.
Mortgages issued in the last 2 years at ~2.75% are probably worth less than the debt now. So it might actually be the case for a lot of these loans.
That being said, the discount is not going to be anywhere close to 50%.
The difference in the discount would be evened out by the difference in the interest rate you'd have to refinance at almost exactly.
Considering the cost of refinancing, if you bought your own debt with some new debt from some new mortgage company - this would be a losing proposition for 99%+ of mortgages.
First, it seems they're selling at something like 85%, so they're selling a $300k mortgage for something like $250k.
Second, the main reason they're selling because these collaterals have fallen in value and so it now would be much less than $300k.
Third, any $300k mortgages it would be possible for you to get financing for the $250k simply would not be sold as part of such a discount package (because those are likely worth the full $300k or close to that), the discounted sale gets those loans for which they (knowing all the data) know that an equivalent financing won't be granted in this market - because anyone who'll grant you a $250k financing will rather buy the same thing from a lender for more than $250k as part of a large scale package deal with less overhead; refinancing is a reasonable option only if they can lock in a much better interest rate and thus make it more profitable.
I’d love to see the law change to force owners of debt to give the person that owes right of first refusal whenever debt is sold. (Mostly for medical debt and collections agency situations, but also for mortgages.)
Why would anyone choose to lend under such terms?
One of the big problems that happens a lot with mortgages is that the bank sells it to this other bank and mix ups can cause all kind of problems for the debt holder. Give the debtor right of first refusal at price they are about to sell (simple form letter that they have 30 days to respond to). 9 times out of 10, debtor just lets it happen.
But what WILL happen is a company will come along, offer what are basically refinance loans to service this situation, and the debtor gets helped out.
The whole practice of tranching is toxic to begin with and if this discourages that its a double win.
Mix ups with selling mortgages or servicing rights do occasionally occur but they are rare and impact relatively few borrowers.
That's exactly the point. There is nothing prohibiting them from doing that but they don't do it anyway because it makes life a little more difficult for them while making like substantially more difficult for the debt holder. Parent post is suggesting enforcing an inversion of that dynamic - put more power in the hands of the debt holder and less in the hands of the debt owner. A law is absolutely required to overcome the natural incentives at play, if that is the goal.
Your proposed law wouldn't even make life easier for anyone but the richest debtors, who don't need a law to protect them. The vast majority of people live paycheck to paycheck and have de minims savings. If you offered them a 30% discount to pay off their mortgage (or even a 50% discount), they have no way to come up with that payment without going out and obtaining another loan.
B) It's not really necessary to consider how the lender will fund the infrastructure necessary to comply with the law. That's sort of how laws work. If you want to operate in that space, you have to obey the law or not operate in that space. Either they will stay in that business or they won't. What is necessary to consider is the secondary effects of that decision, which would likely be decreased access to credit for borrowers with marginal credit. Might be OK, might not.
C) RE: whether it's a viable business model, see above.
D) RE: benefiting richer debtors proportionally more than poorer ones, that's relatively easy to handle - we have all kinds of policies that are targeted to benefit one economic class over another. Most of them are tuned to help the richest, but there are plenty tuned to help the poorest or the middlest. It's not a problem so long as we build in the correct dials to tune those parameters.
E) RE: unavailability of credit to low-income debtors to take advantage of this scheme - I have no doubt that new enterprises would form to take advantage of this economic niche. It might be higher risk, and come with a somewhat higher rate, but it might be viable to make a marginally risky $40,000 loan where it would not be viable to make that same loan at $100,000, particularly if the loan was secured by the property. That is in effect already happening, it's just the bank buying the loan from another bank that gets the benefit.
This stance hits me as entitlement cloaked within anti-capitalism/pro-consumerism.
The argument you replied to isn't that the law should be changed to allow this to be offered to the debtor.
The argument is that the law should be changed such that this is required to be offered to the debtor, prior to offering an external sale.
Ofc, the original buyer could offer instead offer to refinance.
This whole thing reeks of entitlement to me. If you take out a loan expect to pay it off. Don't expect that if the lender goes belly up that means you got some get out of jail free card.
The current system, to me, has just as much entitlement, just from the other side. Why should it be some unrelated party that benefits from the lender's misfortunes. The lending is between two parties, and it seems reasonable to keep it that way unless both parties agree not to.
They would have to have a discount much lower than 30% to homeowner, and a way steeper discount to the firm buying the remaining bundle of people who didn’t take the offer.
People with decent credit will simply get a new loan for 70% of their principal; kind of like refinancing.
That means rather than having to buy both the good and bad loans in bulk, firms can cherry pick the loans they want to buy.
Any loans left after that cherry picking will have already been turned down by the potential buying firms. They're effectively un-sellable, because everyone has already turned down buying them by refusing to issue a new loan in it's place.
If you first skim off the "best" loans, the ones held by debtors in a position to pay them off at a reduced rate you know have a higher risk/lower value bundle.
So what do you do with the new remaining bundle of loans? Offer those debtors the ability to pay them off at even greater reduced rates?
Eventually you iterate down to the highest risk lowest value bucket that almost nobody would see the value in purchasing.
The remaining business is doomed to fail now but even more painfully.
It lowers the debt total of the borrower, and makes the assets held by the new lender less toxic.
Seriously, stop making up fake numbers and look up price quotes on real mortgage-backed securities. The real world doesn't work anything like what you're describing.
Then the shareholders of the lending company wouldn't be rich-people-broke-where-someone-buys-them-out-and-somehow-they're-all-still-rich they'd be actual-broke-where-they-lost-all-their-money-on-a-stupid-venture.
I'd also note you could flip that argument on its head - more people seeking out unstable lenders would help capitalize them.
IIUC, the lender who sells the debt takes a loss, but the amount of debt owed by the borrower remains the same.
For those who need a primer, check out https://www.compareclosing.com/blog/all-about-mortgage-tranc...
https://www.npr.org/2014/04/01/297686724/on-a-rigged-wall-st...
PFOF and HFT mean that no matter how much you win, the exchanges and HFTs will always win more.
It's extremely hard to win as a small-money day trader, so I won't play that game.
Also, Citadel is buying retail order flow because they’re reasonably certain they can capture the spread and not get run over by an institutional trader with more information than the market maker. They aren’t frontrunning your 20 share order because you aren’t going to move the market by purchasing 20 shares.
Zero commissions and tight bid/ask spreads are better for an individual than no PFOF and $5/trade transaction fees with 25-50 bps bid/ask spreads.
https://www.kalzumeus.com/2019/6/26/how-brokerages-make-mone...
Even the worst of the liar loans didn't sell that low (the whole problem is nobody knew how to price them, but they were sure they were worth something).
If you ignore all the transaction/processing fees. You could borrow some number less than your principal balance at today's rates ~5%, and use that to buy your current mortgage at a discount (it dropped in value). But your monthly payment would end up the same. Higher interest on a lower principal balance.
Roughly.
A 100k loan today that pays back 105% a year from now isn't worth 100k.
Only bad debt is sold for such a discount. A normal mortgage with nothing wrong with it will be sold at full value, i.e. sold to someone who wants to make money on the interest.
It's a tale as old as commerce. You start by operating a service (brokerage, mortgage underwriting, web storefront, SaaS/PaaS, etc.) You get really good at it, and decide that you might start to warehouse some of the inventory that your customers handle, to improve efficiency and bundle/upsell. Time passes and the value of the inventory you hold exceeds and then dwarfs the value of your platform/service business. Then market conditions change, the value of your inventory declines, your budget blows up and you go bankrupt, learning the hard way that combining two businesses with very different capital dynamics is hard and hazardous.
Also there is a difference between subprime lending and responsible lending that is nonetheless susceptible to interest rate risk. So far we have mostly the latter.
Nothing like terrible mind you, but there are strong questions about interest rates, demand destruction vs inflation, low unemployment (right now anyway), but slowing growth, etc. etc.
If you lend money that's paid back over a long period of time (like a mortgage) and you're funding it by borrowing money that needs to be paid back much sooner, you're going to have difficulties when the market moves to make that short-term funding less available. It's a fundamentally risky position to be in.
Banking regulation introduced since the 08 crisis (Basel III) forces banks to rein in these mismatches, but per the article many of these lenders are not banks..
A bank gets money from depositors that it lends out but I don't understand how a non-bank mortgage company works.