Why the Mortgage Market Needs Its Fixes Fixed – Serialpressit (News)


When the U.S. residential-mortgage market was hit by pandemic-driven turmoil, the Federal Reserve and Congress took quick action to protect lenders and homeowners — and keep that turmoil from upending other markets. But the side effects of those actions are now causing headaches within the mortgage universe and potentially for home buyers and sellers.

1. What’s happened in the mortgage market?

As the bad news about lockdowns and their economic disruption sank in, one of the hardest hit groups were Real Estate Investment Trusts, or REITs, that were focused on buying commercial mortgages. REITs are highly leveraged, meaning they invest mostly with borrowed money. As the market prices of their real estate assets dropped, they were inundated by margin calls from their lenders.

2. What did the REITs do?

To raise cash they started selling off their most liquid assets, so-called agency MBS — mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae, three government-backed giants of real-estate finance, whose products are regarded as virtually as safe as Treasuries. That helped drive yields up at a time when the Fed was hoping to see them drop. Prices for agency MBS also dropped over worries that falling interest rates would lead to a surge in refinancings, which returns funds at par earlier than expected, hurting mortgage-bond performance.

3. What did the Fed do?

Over the weekend of March 15 the Fed announced it would purchase “at least” $500 billion U.S. Treasuries and $200 billion of agency mortgages to stabilize the markets and support the flow of credit. The very next weekend all limits to mortgage purchases were removed, and as of the end of March the Fed had purchased $291 billion in just twelve trading days, an unprecedented pace of buying.

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4. Did that work?

Yes and no. It helped REITs and other investors by giving a robust boost to mortgage performance and prices — with the U.S. MBS index excess return roaring back to end the month at just -0.21% after hitting -2.22% on March 19. But the other side of the equation, the mortgage originators who lend money to homeowners before selling the mortgages were hurt. To hedge against the risk that the value of the mortgages they may issue might fall before they can sell them, mortgage lenders short the mortgage market — that is, they sell bonds now with a promise to buy them back later. Under normal conditions this protects them from adverse movements in interest rates.

5. Why didn’t this help now?

When the Fed drove mortgage-bond prices up, the lenders’ short positions dropped precipitously in value, triggering margin calls. Usually, mortgage lenders would make up for any loss on the short side with gains on the new mortgages in their pipelines, but like so many other transactions, house purchases and new mortgage closings have all but dried up with the lockdowns imposed to slow the spread of the virus. The Mortgage Bankers Association calls the situation “unsustainable.”

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6. What did Congress do?

Inside the massive $2 trillion spending bill passed by Congress and signed into law on March 27 is a provision allowing homeowners with mortgages backed by Fannie Mae, Freddie Mac or Ginnie Mae the right to request forbearance on their payments for up to six months without fees, penalties, or extra interest, with a possible extension for another six months. It’s meant to prevent a wave of foreclosures from the sudden economic stop.

7. Who does that hurt?

Mortgage servicers, who collect mortgage payments from homeowners and forward that money to bondholders. Servicers generally operate without a deep capital reserve, and any prolonged exposure to having to make those payments — or any dramatic increase in those payments — can become a solvency issue. The Mortgage Bankers Association estimates that if 25% of borrowers postpone payments for 6 months, the cost could be as high as $75 billion. Federal Housing Finance Agency director Mark Calabria suggested that as many as 700,000 mortgages could have payments delayed by the forbearance provision.

8. Who else is hurting?

Companies making what are known as non-qualifying mortgages, or non-QM. Those are loans that don’t meet the conditions for being packaged into agency MBS, which means the federal government is not responsible for guaranteeing their payment to bondholders. With the prospect of widespread defaults looming, a number of non-QM companies have already laid off large portions of their staffs or halted non-QM lending all together.

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9. Why does all of this matter?

Usually, interest-rate cuts or bond-buying by the Fed lowers mortgage rates, making home buying more attractive and thereby stimulating housing activity. But many in the mortgage field fear that these effects will be offset by their impact on mortgage lenders, and could slow down lending or raise rates. Similarly, while a wave of foreclosures is in no one’s interest, there are worries that a large-scale forbearance program would create a new risk for the market that would also serve to drive up rates at just the time the Fed would like to see them go down.

10. How might these problems be fixed?

Some mortgage investors feel that the Fed should wield a smaller hammer and keep mortgage-backed securities prices anchored rather than rising, but where exactly the proper level should be is a matter of debate. As for the mortgage servicers, federal regulators said that they want to see if other measures address their liquidity problems before considering a request for aid to make up for delayed payments.

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