First, I would like to welcome you to The Secondary Market Overview, designed not only to keep you informed with regard to what is happening in the markets, but more importantly, how it relates to loan officer production within our industry. What good is being knowledgeable about what is happening if you don’t know how it will affect your business? To that end, we will try to make this message as non-technical as possible. My good friend, Eric Holloman, a secondary expert and chief executive officer of RateLink, will advise me on the technical aspects where necessary.
I have been writing about the mortgage industry consistently for more than five years now and have been teaching loan officers how to become an expert in all areas, including the secondary markets for 30-plus years. The secondary market led the real estate boom earlier this decade. It also led the collapse of real estate. And that is the message I want to give you in this opening column—what caused the issues we faced and where might these issues lead us in the future?
With regard to the future, I asked Eric Holloman what are the most pressing issues that could have a major impact upon the secondary market in the coming months. Eric, pointed out three such issues that we will be following closely—
► The fate of Fannie Mae and Freddie Mac. First, Moody’s Investors Service predicted the “winding down” of the agencies. Then, the Mortgage Bankers Association (MBA) called for the agencies to be replaced by private “cooperatives.” Of course, the major members of the MBA have always competed with the agencies.
► Will the industry be able to replace the warehouse capacity it has lost? The credit and banking crises has crippled the industry in this regard. Will the government provide a solution through Ginnie Mae or another entity?
► As the real estate market begins its recovery, will the secondary market, and thus lenders, be able to loosen credit standards somewhat. We know we are not going back to the “fog the mirror” days, but it would be good for lenders not to require pristine credit in order to purchase a home for anything but FHA.
What happened to cause these things? Many trace the rise and fall of the real estate debacle to the sub-prime industry. Actually, it goes back further than that—much further. I could trace it back to the Great Depression, but I will start with a more contemporary event. The Savings & Loan (S&L) Crisis of the late 1980s set the stage for what happened 20 years later. How? Before the mid-1980s, the S&L industry was the major player in real estate lending. In the mid-1980s, we had a real estate boom and a refinance boom driven by low rates. Sound familiar? Of course, back then, low rates were defined as eight percent! A little perspective … earlier that decade, rates rose to above 15 percent. The bond market collapsed in March of 1987 and rates went back to double digits overnight. After overbuilding, we had a collapse in the real estate market. To exacerbate the problem, most S&L institutions held loans in their portfolio. There was little guidance from the feds on how to value these mortgages. Back then, we charged points on all mortgages, and it was not unusual for the S&L to book the points as income and put these loans, many of which were adjustable, on the “books” at 100 percent of the value of the mortgage.
We now know what happens to the value of mortgages that are held by an investor when rates go up. The values go down. Defaults increased and that also lowered the value of the holdings of the S&Ls. Many of the buildings defaulting were commercial. Perhaps an S&L had a $10 million loss on a large building. When that S&L needed to raise assets, they turned to sell mortgages in the portfolio, but when these were assessed, it turned out that they were tens of millions of dollars lower than their “booked” value. So, a $10 million loss all of a sudden turned into a $40 or a $100 million loss. From a bank’s perspective, if an asset is lower in value than previously indicated, this turns into a loss when the valuation changes. This played out all over the country, and basically, the whole industry collapsed.
Many changes came as a result of the S&L crisis. For one thing, appraisers were now required to be licensed for the first time. Also, the Financial Accounting Standards Board (FASB) adopted “Mark-to-Market” rules. Without going into the technical aspects, these rules basically discouraged financial institutions from putting mortgages in their portfolio. The way to avoid future risk in valuation was to sell the loans. And that is where it started. Stay tuned for the conclusion as to what happened and some clues as to what will happen in the future and how it may affect your business.
In the meantime, let’s address more current events. We have several factors still impacting the markets and they are conflicting. For one thing, the recovery is starting to take shape, and as long as there is positive economic news, this will put upward pressure on rates. Also exerting upward pressure on rates is the tremendous amount of money the government is borrowing. On the other side of the coin, the credit markets have not recovered. Though the feds are slowing their purchases of Treasuries, they will continue to purchase mortgages. This will continue to keep the spread between Treasuries and mortgages more narrow than they should be considering the credit crisis. With unemployment hovering close to 10 percent and tons of foreclosures still hitting the real estate markets, the government cannot afford for rates to increase too fast and thereby jeopardizing any recovery on the horizon. These conflicting forces are expected to keep volatility in the markets high for the foreseeable future, with more risk to the upside than down. That risk changes only if we get significant poor economic news in the next 30 days …
Dave Hershman is an author for the mortgage industry with eight books and several hundred articles to his credit. He is also head of OriginationPro Mortgage School and a top industry speaker. He may be reached by phone at (800) 581-5678.