Have you noticed the news headlines mentioning a “mortgage crisis” lately? This topic can be confusing so I wanted to help break it down and make it easier to understand. More importantly, I’d like to discuss how you and I are likely to be affected by all this. For reference, here are examples of a few recent headlines:
Mortgage Crisis Prompts U.S. to Weigh Harder Line With Borrowers – …Bloomberg
Another financial crisis is brewing in the mortgage market – …Curbed
Coronavirus mortgage bailout: ‘There is going to be complete chaos,’ says industry CEO – …CNBC
The first thing to understand is that this “mortgage crisis” is not what happened leading up to the 2008 housing crisis where banks and lenders were giving out loans to people who could not reasonably afford them. That ended in massive foreclosures and ultimately a nationwide housing market crash. For this “crisis”, we have to examine the impact of the 2 trillion-dollar stimulus package that was recently passed. An important detail in the stimulus package is that the Federal Reserve is now buying mortgage-backed securities (MBS).
A mortgage–backed security (MBS) is an investment similar to a bond that is made up of a bundle of home loans bought from the banks that issued them. Investors in MBS receive periodic payments similar to bond coupon payments. The MBS is a type of asset-backed security.
So What Is The Crisis?
When a bank provides a mortgage to a borrower, the bank does not hold that mortgage debt on their books and collect a 3-4% coupon for the next 15-30 years. Instead, they often bundle these mortgages into an MBS and then sell that security to investors in order to get the mortgages off their books so they can make more loans to new borrowers.
The problem is, investors like you and I have slowed down on buying these MBS from the banks due to the current economic conditions (AKA there is fear and uncertainty in the market), so the banks were left holding these MBS on their books. This means the banks were running out of capital to lend out to new borrowers because they couldn’t offload these mortgage balances from their books. In order to keep the lending system moving, the banks decided to offer higher yields to investors to incentivize them to buy the MBS. While this is good news for MBS investors (they get a higher yield on their investment) and for the banks (they can offload these mortgages onto investors), it also means interest rates went up on new mortgages which is a bad thing for buyers and borrowers (they now can afford less and/or borrow less). In an attempt to “fix” this issue, the Federal Reserve jumped in and started buying these MBS securities to essentially back up the banks and keep the system moving.
Problem Solved – Right?
Not quite. When you or I apply to get a home loan, we lock in a rate on our mortgage ahead of time before we close. When we lock in a rate, the bank is essentially agreeing to give us that “locked-in” rate for our upcoming mortgage, but the bank doesn’t know what the actual interest rate is going to be at the time of closing. Because the bank doesn’t want to lose money on their bet in the event that interest rates change; the bank “hedges” or offsets their risk by betting against the investment.
Banks do this by shorting the MBS. But when the Federal Reserve steps in and starts buying the MBS, it drives interest rates down, causing the price of these MBS to go up. Since MBS trade similar to bonds, when interest rates go down, the price goes up and when interest rates go up, the price goes down. This causes banks to lose money on their short-hedged positions because they were betting that the price of these MBS would go down. To offset these losses, banks have to put up more capital and that means there is now less money to lend to new borrowers.
Hang In There…
There is one more layer of complexity to add to this situation. That is the “missed mortgage payments” you may have also seen in the news recently:
Mortgage Firms Brace for Wave of Missed Payments as Coronavirus Slams Homeowners – …Wall Street Journal
New York will let some residents skip 3 months of mortgage payments as coronavirus spreads – …Housing Wire
Homeowners hurt by COVID-19 can delay mortgage payments, but some say they’re anxious and confused about the real cost – …USA Today
Another section of the recent stimulus relief package includes potential mortgage payment forbearance of up to 180 days, with a possible extension of an additional 180 days. Here’s the kicker, even though people may not make their mortgage payment, the mortgage servicer (the one who handles and processes those payments) is still on the hook for making the payment. Mortgage servicers are obligated to keep the money flowing into the MBS, which are bought by investors like you and I who are looking for a safe and stable return on our money.
If a large number of people hold off on making their mortgage payments, then the question becomes…how badly will the mortgage servicers be hurt and how long can they stay afloat since they must continue making the payments even when the borrowers do not?
· If you are in a position to invest right now, you might be able to buy certain assets at a lower price.
· If you are selling your home, it could be slightly more difficult to get a high price and/or to get a buyer who is qualified for a mortgage.
· If you are buying a home, the lending criteria might tighten up a bit
This situation is likely going to affect banks and lenders in the short-term rather than having profound effects on you and I directly. I hope this blog provides some context and explanation for what’s going on, so the next time you read a headline about the mortgage crisis, you have some additional background and insight.
Please keep in mind, this is not financial advice and I am not an expert or an economist. This is only my interpretation and opinion of what is unfolding as of this writing. As always, I’m happy to be a resource for anyone looking to learn more. If interested, please select a time that works best for you.
To Your Success,
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action