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Why the federal government now holds nearly 50% of all residential mortgages
Published: Oct 16, 2015 5:46 a.m. ET

Borrowers seeking large mortgages or with weak credit may struggle Bloomberg

By Daniel Goldstein
Personal finance reporter

Mortgage lending levels are beginning to recover from the real estate crash of the Great Recession, but a large number of potential American homebuyers are still being locked out of the mortgage market.

That’s because although you may be able to get a mortgage from your bank, few outside the government want to buy it. And that makes your bank less likely to write additional loans.

When big mortgage buyers like Fannie Mae and Freddie Mac assume the risk of a loan, the bank or lender that makes the loan no longer has to carry the risk on its books, which means it can go out and make more loans. In addition, when private buyers, like investment banks and hedge funds, buy riskier loans that pay higher interest, known as private label securitization, the banks that originally sold the mortgages can continue lending to less-than-perfect borrowers.

Most Americans might not know a mortgage-backed security from a credit-default swap, but they probably know why the mortgage market helped cause the crash in the U.S. economy in 2008. Banks sold risky home loans that should never have been drawn up to Fannie Mae and Freddie Mac, the biggest backers of residential mortgages, as well as private investors like Lehman Brothers and Bear Stearns. When those mortgage loans defaulted, the collapse of Fannie, Freddie and the private investment banks soon followed.

Now, nearly 10 years after the start of the collapse, the mortgage market is on more solid footing, with foreclosures down and lending up, but the private buyers of mortgages, such as hedge funds, bond funds and investment banks, are still wary from being burned in the last crash, so they’re buying less than 10% of the mortgages they did a decade ago.
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As a result, government-sponsored enterprises have to buy up the majority of the loans to create liquidity in the market. According to the Housing Finance Policy Center of the Urban Institute in Washington, D.C., the private label securitization market was valued at $718 billion in 2007 and plunged to just $59 billion in 2008. It is valued at just above $64 billion today.

Fannie Mae and Freddie Mac can only buy residential mortgages up to $417,000 for most of the country (and $625,500 in certain areas), so for larger loans and subprime loans, banks must hold the remainder of the residential mortgage market, and thus are less likely to make riskier loans.

That means the federal government is shouldering more than $5 trillion in mortgage risk out of a residential mortgage market of about $11 trillion, according to the Federal Reserve. That’s close to 50%, and up from 40% in 2007. By comparison, only 7% of residential loans were federally guaranteed in 1981, according to the New York Fed.

“Many investors don’t believe there is enough protection to make it worthwhile to invest in mortgage-backed securities,” David Stevens, the president of the Mortgage Bankers Association, the main Washington, D.C., lobbying group for the mortgage industry, said in an interview.

The continued disinterest in private label mortgage backed securities in today’s environment is contributing to the slow recovery, he said, because banks are unwilling to write riskier loans that can’t be sold to Fannie Mae or Freddie Mac. ‘What that means is that the community bank that has a long relationship with perhaps a self-employed businessman who they know well, they can’t get him a loan, because nobody in the private markets wants to purchase that loan.”

And Laurie Goodman, the director of the Housing Finance Policy Center, wrote in a blog post last week: “The loss of the PLS market could render mortgage securitization an exclusively government-sponsored activity and lock borrowers who need larger loans or have less than pristine credit out of lending.”

Thus, banks that make these types of loans have but two choices: Keep the loans on their books (so-called portfolio lending), which increases risk for the bank if the loan goes bad, or find a private buyer who will trade the higher-risk of poorer quality loans for the higher interest rate payments, which even today can be as high as 7% or 8%.

So what has to be fixed? Goodman laid out some suggestions in a report last month, which included, among other things, better servicing standards, meaning that the investor knows when a loan is modified with a new rate or when delinquent payments are piling up.

And when it comes to buying mortgage-backed securities, investors should: Read. The. Fine. Print. “When investors bought a deal before the crisis, they read the deal summary but not the prospectus,” Goodman said.



http://www.marketwatch.com/story/why-the-federal-government-now-holds-nearly-50-of-all-residential-mortgages-2015-10-16?link=MW_home_latest_news