The 2008 financial crisis was caused, in part, by mortgage lenders taking on too much risk. Now, the pendulum has swung so far in the opposite direction that the private sector has all but ceased taking on mortgage risk any more.
Why it matters: Private-sector risk aversion has prevented millions of Americans from buying houses. It is also driving banks out of the mortgage game. That might be OK, if the nonbanks weren't disappearing too, and unlikely to return any time soon.
Flashback: Banks paid more than $100 billion in mortgage-related fines after the financial crisis — a stark reminder that such activity can prove extraordinarily costly.
- That, alongside more stringent government rules about how much capital banks need to allocate to such activity, has resulted in what one banker described to Axios as a "derisking" in mortgage lending — a/k/a an ongoing exit.
How it works: Most mortgage lenders make money in two ways.
- After they originate the loan, they hold it on their books for a relatively short amount of time before selling it to the government — either directly (the Federal Housing Administration and the Department of Veterans Affairs both buy mortgages) or to agencies like Fannie Mae and Freddie Mac.
- After selling the loan, the originator generally continues to service it — to collect mortgage payments and send them on to the loan's new owner. Servicing fees are low, generally about a quarter of a percent, and servicers need to make the payments even if the homeowner is in arrears.
Banks retreat
Bank capital and liquidity rules implemented after the 2008 financial crisis make both activities unattractive to banks trying to maximize their return on capital — especially once compliance costs are added in.
- "The Basel rules on capital are so punitive the banks really can’t afford to be in the servicing business," Urban Institute fellow Ted Tozer tells Axios.
- Add in an unknown chance of fines and/or shaming from regulators and politicians, and banks have broadly concluded this isn't a business they want to be in.
Where it stands: Nonbanks now originate 71% of agency-backed loans and 86% of government-backed loans, per Inside Mortgage Finance.
- While those figures are the result of a long-term trend going back more than a decade, they're probably growing faster than ever at the moment. "Over the last month, I think it’s begun to accelerate," BTIG analyst Eric Hagen tells Axios, as deposits have fled banks.
- Banks still eclipse nonbanks in the relatively small market for jumbo loans that aren't backed by the government, since such products help to build relationships with high-value customers, and can be held as long-term assets on the bank's balance sheet.
The big picture: The mortgage market is now dominated by nonbanks that operate with relatively thin cushions of capital and need substantial economies of scale.
- Between March 2021 and January 2023, total mortgage originations fell by 83%, per Black Knight. Refinancings — which were more than 70% of the total at the beginning of the period — dropped by a stunning 95%, as spiking interest rates killed demand.
- Refinancings are the relatively cheap and easy way for nonbanks to make money in the mortgage business. Without them, more of those lenders are likely to close.
- Given that most outstanding mortgages are at 3% or lower, refinancings aren't going to pick up any time soon. The result is that few if any new nonbank lenders are likely to enter the market, even as the number of existing lenders continues to dwindle.
Why it's so hard to qualify for a mortgage
Because loan servicers have to make mortgage payments even when homeowners don't, they have a strong incentive to avoid that situation.
- The result is that while government agencies like Fannie Mae and Freddie Mac are willing to buy riskier mortgages, lenders aren't willing to originate them, and would-be homebuyers with less-than-stellar credit find it extremely difficult to buy a house.
"It is becoming increasingly difficult for banks to stay in the mortgage business, which ultimately hurts everyday Americans," wrote JPMorgan CEO Jamie Dimon in this year's shareholder letter.
- The Urban Institute estimates that if mortgage credit reverted to normal levels — below the excesses of the mid-2000s but much looser than today — an extra 1 million loans could be written per year.
The problem is not so much that lenders aren't willing to take on credit risk. As the higher default rates on government-backed loans demonstrate, lenders will do that — if they're paid more for servicing such loans. (FHA and VA loans typically pay about 0.45% to servicers, compared with the 0.25% paid by Fannie and Freddie.)
The real issue isn't credit — it's liquidity. Lenders need to be liquid enough to front a large number of mortgage payments pending some kind of resolution like a foreclosure or a workout.
- Many servicers, for instance, would have run out of cash very quickly during the early weeks of the pandemic were it not for official government mortgage forbearance programs.
The bottom line: So long as the government continues to backstop mortgages, they won't go away. But homebuyers shopping for loans aren't going to find themselves with a lot of choice.
