Crash Goes The Mortgage Market

From the email inbox this week:

"Hi Donna,

Well, I've been hearing all the scare stories on the news and from my investment firm about the terrible situation in the mortgage industry these days. I know you have a better handle on it than probably most of the talking heads. Do you think there is going to be a problem with me getting a mortgage? I'm really sick of all the stories about banks backing out of mortgages at the last minute already! What is your experience these days? Of course I am nervous with having already put down a sizable deposit toward the house!

Thanks for any words of wisdom."


You would not BELIEVE how many emails like this I've had this week ... one client even emailed asking, "Am I going to lose my house?" (My reply, for the record, was, "As long as you're making the payments on time, no!")

You'd better grab a cup of tea or coffee or Jack and Coke or something ... this is going to take a minute! : )

People are always going to buy houses, and people are always going to refinance the houses they've got for one reason or another. The mortgage market isn't going to disappear. The feds are being rather myopic (IMHO) about it all, because if we flew airplanes or built cars, they'd be falling all over themselves to bail us out (but we don't, so they aren't).

What's going on now is essentially a crisis of confidence, but on an incredibly massive scale. Let's say that your asset portfolio includes a few accounts with a local brokerage -- your friendly neighborhood Waddell & Reed office, maybe (since I have a client who's a W&D broker, ha), a guy called Jim. You and Jim sat down and plotted your long-term goals and a strategy to reach them. The strategy included buying some mortgage-backed securities (MBS), because everybody knows that they're one of the most stable investment vehicles around -- after all, wouldn't you do pretty much anything to avoid foreclosure? Sure you would, and so would everybody else, which is what makes MBS so attractive. So you tell Jim to purchase MBS bits with a certain percentage of your portfolio amount, and to keep that amount level with each contribution you make to the account. Life is good!

One day you're listening to the news while puttering around doing something else, and you hear that there are a record number of foreclosures going on all around the nation just now. You think to yourself, "What? How can that be? And hey -- I'd better call Jim and tell him not to buy any more MBS for me." So you ring Jim, and you tell him, and he says okay. A couple of weeks later, you're watching the late news before bed, and you start hearing how subprime mortgages are total crap, and how they're horribly risky and it's some talking head's opinion that they should never have been available to anyone ever. The talking head goes on to say that subprime loans and loans with little or no income or asset verification (we call them stated-income or no-doc loans) are going to be the things that crash the whole mortgage market. "Oh, no," you think to yourself, "I've got to call Jim NOW and tell him to get rid of all the MBS in my portfolio!" So even though it's late, you hit Jim's beeper, and when he calls back you tell him that first thing in the morning, he's got to get rid of ALL the MBS you've got, so he does.

Now ... take you ... and multiply it by about 30 million individual investors, loads of life insurance and annuity companies, and a boatload of pension funds ... and see where the trouble comes from? You heard someone say something about something, and that initially set off a little bell that says okay, we won't buy any more of those ... then later you hear something more about it, and that sparks a panic in you to get rid of them before they do so much irreparable damage to your retirement and investment funds that you'll wind up living in a refrigerator box under an interstate bridge.

The scariest part of it is that this is eerily similar to the lack of confidence that led from the stock market crash of 1929 to a run on the local banks and then to the Great Depression. The biggest difference between then and now is that we have CNN, MSNBC, BloombergTV, and the World Wide Web to make sure that the hysteria can spread far and fast.

The truth of it all is that there ARE more foreclosures going on this year, and it IS a record number. However, what the talking heads aren't saying is that it's nearly the very same percentage of all outstanding home loans that's been foreclosed on every year for a long time. Look at it this way: if there are 100 mortgages made every year, and 5 of them go into foreclosure the next year, there is a 5% foreclosure rate. If there are 1000 mortgages made in any given year (a new record number!), and 50 of them go into foreclosure the year after that (also a new record number!), then yes, there are 10 times more foreclosures than there were last year ... OMG, eek, the sky is falling! Oh, but wait ... it's still a 5% foreclosure rate.

The fact is that the mortgage rates have been so low for so long that there are far more loans out there to be foreclosed. Since real estate prices have been up as well, mortgage loan amounts have gone up proportionately, which leads to a higher dollar figure in foreclosure than ever before. It's simply statistics, but Joe Average only knows what he heard from Peter Jennings -- that there are ten times more foreclosures this year -- and has the knee-jerk reaction that you had when you heard, resulting in your calls to Jim to get your butt out of those MBS right the hell now.

So why are so many mortgage companies going under? Why did Countrywide have to draw down $11.5 billion in credit lines this week? Why did the Federal Reserve bend its own very strict rules for Citibank and Bank of America? It's liquidity ... the ability to continue funding wholesale mortgage origination on a daily basis.

There is an event in Mortgage Land known as pooling, which is where loans are assembled by wholesalers from many different sources, then grouped together by the characteristics of each individual loan (credit score range, loan amount range, fixed or adjustable, loan term, and a bunch of other things) and sold in a pool into Fannie Mae or Freddie Mac. You want to understand what happens to a mortgage after the loan is closed in order to grasp the whole enchilada (and it's shredded chicken with ranchera sauce, yum).

Let's say that I'm the First National Bank of Donna, and I have $50 million that my board of directors has set aside to make mortgage loans. I set my retail rates and fees to be competitive with those of the other mortgage lenders around me, and I let people know that I'm ready to make loans. Soon, I'm a busy little mortgage maker, and before too long passes, I've loaned out all $50 million to happy homeowners. So ... now what? It's taken me eighteen months to loan out $50 million, all secured by real estate mortgages with terms varying from ten to thirty years. The local marketplace knows I'm here, and it knows I do a great job, and there are more people who want me to do their mortgages. I can either turn them away, telling them that it'll be ten to fifteen years before I have enough of my $50 million back to make them a loan ... or, I can sell them to someone else. At that point, I look through each file and make sure that it fits the rules that Fannie Mae and Freddie Mac have set down for notes that they will purchase, group them together by type, then box them up with a note on the top of each box saying what's in it. I can choose whether to continue to take the payments from my borrowers and hold their escrow accounts (known as "servicing retained"), or whether to kiss them off lock, stock, and escrow to someone else (known as "servicing released"). By selling the notes upstream to larger lenders (or in some cases, directly to Fannie Mae or Freddie Mac), I am constantly replenishing my $50 million loan proceeds account and making a premium (usually expressed as a percentage of the dollar amount of the loan) for each loan I sell. Ah, capitalism!

Everyone is having a rough time getting the international marketplace to remain jazzed about the American MBS enough to keep buying them. The UK is teetering on the edge of a similar meltdown (we exported our subprime and no-doc ideas to them, and it's jumping up to bite them on the posterior too, although their PM was most recently the Chancellor of the Exchequer, and as such has a clue and took swift and decisive steps to stop it there), which isn't exactly inspiring other nations to think our MBS are so great.

So, then, the short version of an answer to the question above is that if you have good credit (which we define by a credit score of 620 or higher) and easily documented income and assets (meaning that you can produce either pay stubs and W-2s showing what you make and/or tax returns that reflect your actual income and statements from your bank or investment firm or 401K in the US that indicate what you've actually got stashed - underwriters aren't typically excited in a good way about offshore accounts or money hidden in the name of a child), then no, you aren't going to have a problem getting a permanent mortgage. The rate may not be as low as what we've had over the last three years, but if you fit into the box that I just described, you're typically not going to have a problem getting a loan for your house (or your car or your boat or your college education or whatever).

The people who are going to have problems in the very near future (like starting last week, ha) are people who have some or all of these factors: low credit scores, high debt ratio, derogatory credit information (even if it's too old to impact the score), difficulty proving income and/or assets, and little or no assets in reserve after closing. There will always be FHA and VA loans, too, since they were created by an act of Congress. It's just that for certain chunks of society at large, getting credit is going to become rather difficult and it's going to stay that way for a while, maybe forever. At least it'll stop (or seriously curtail) this tendency we've had lately as a nation toward buying beyond our means. Homebuilders may not like it, but I really don't think it'll wind up being a bad thing.

Oh, and I haven't heard about any lenders backing out of things at the last minute. Lots of investors are performing major surgery on a lot of programs -- or suspending them altogether for the time being -- but most of them are doing that in response to their funding sources telling them they have to in order to continue having any funding liquidity at all. The only lenders that I know of who are "backing out" are ones who are slamming shut, and you can't really expect a loan to be funded by an entity that isn't there anymore. This has happened a couple of times in the last several weeks (although thankfully not to any of the files that I've got going), and the biggest end result of it so far is that the lenders who are still there are getting backed up with submissions being transferred to them to take up the slack. In the main it's a matter of more time spent waiting for underwriting attention, because suddenly the 25,000 files that were at XYZ have to go to ABC, DEF, GHI, JKL, and MNO, who were humming happily along but now have to accommodate an additional 5,000 files apiece.



One further note: Just because a lender goes under doesn't mean that anything awful is going to happen to a home loan that you've already got. The promissory note that you signed at closing binds the lender as much as it binds you, but it also binds that lender's "successors and/or assigns, as their interests may appear" (which is what shows up on your homeowner's insurance declarations page in the mortgagee clause, so if you've ever wondered what ISAOA/ATIMA means, there's your answer). If your loan payments include monthly escrows, you don't need to worry that those funds are going to be lost, because escrow accounts are federally protected and can't be seized by creditors or anything like that. Your servicing will transfer to another entity, but they have to keep to the note. Whatever your loan amount, interest rate, and maturity date were on the date you signed will stay the same. All that can change are your loan number, the name of the lender to whom you write the check, and the address to which you send that payment (or the website where you pay online). CAVEAT: If you've got an automatic draft set up, then you will most likely have to set it up again with the new servicing entity, because the banking system doesn't allow that sort of payment method to transfer without an overt act on your part.

Hope this helps; sorry it's such a book. Don't be shy about asking questions if you have them! If I don't know the answer, I'll find it for you.