In recent Senate comments, Federal Reserve Governor Elizabeth A. Duke said that "the failure of the housing market to respond to lower interest rates as vigorously as it has in the past indicates that factors other than financial conditions may be restraining improvement in mortgage credit and housing market conditions." She is absolutely correct. Aside from the overhang of problem loans, housing remains weak because dislocations in the primary mortgage market have limited the availability of mortgage funds. Unless mortgage lending moves to a stronger footing and can better serve the broad housing market, home prices will remain under pressure.
The mortgage industry is currently faced with a series of unprecedented challenges. As widely reported, a number of large players in mortgages have drastically scaled back their involvement in the sector. Bank of America withdrew entirely from the correspondent lending channel in 2011; other major players, including GMAC and Citi, have also scaled back their presence. This has led to fears that smaller lenders dependent on the correspondent channel will have limited options for selling their loan production. (Frankly, regulators should be alarmed at the rapid pace of consolidation in the mortgage market; the increased concentration of the industry has created a new variation on "systemic risk.")
In addition, capital markets distribution continues to be dominated by the GSEs and Ginnie Mae. With the market for non-agency MBS remaining dormant, almost all Jumbo loan production must be held by financial institutions in portfolio. As a result, Jumbo-balance loans are readily available only to borrowers with high FICO scores and significant liquid assets. While there are positive aspects to the improved credit quality of new production, large portions of the market for higher-priced homes have been deprived of financing.
Many of the challenges plaguing the mortgage market are directly traceable to the current legal and regulatory environment. The contraction of the correspondent channel is directly attributable to elements of the Basel III agreement that limit the amount of servicing that can be held by financial institutions without onerous capital treatment. The GSEs have also pursued aggressive policies for putting delinquent loans back to originators even if the loans are properly underwritten and conform to their program guidelines. (This was true long before the most recent dispute between Bank of America and Fannie Mae led to their public break announced this month.) Aggressive put-back policies have made lenders unwilling to lend to less-qualified borrowers, including first-time home buyers, because of fears that the GSEs will try to put all delinquent loans back to them. Finally, the continued delays in implementing mortgage-related provisions of the Dodd-Frank Act have postponed the revival of private-label MBS issuance.
As a result of these conditions, the current all-time lows in headline mortgage rates have failed to benefit large swathes of the housing market. It's notable that most of the programs created to aid the mortgage market have been directed at helping "troubled borrowers" either remain in their homes or refinance their existing loans. The only initiatives directed at the broader mortgage market have been the Federal Reserve's MBS purchases, which at best are a crude tool. While the purchases have tightened MBS spreads, the benefits have nonetheless flowed through to only a limited number of borrowers.
Regulators and policy makers need to respond to the issues impacting the mortgage market. While not a panacea for the housing market's vast problems, a concerted effort to broaden the availability of purchase mortgage money to borrowers with weaker credit and finances, as well as those looking to buy homes using Jumbo-balance loans, would be an important step toward reversing the continued slide in home prices.
Bill Berliner is Executive Vice President of Manhattan Capital Markets. He is the co-author, with Frank Fabozzi and Anand Bhattacharya, of the recently-released second edition of Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques. His email address is bill_berliner@manhattancapitalmarkets.com.
