This is the best explanation I have read about the current conditions. Posted with Authors permission. I hope this helps us all….
The Dominoes of Mortgage Lending
An Assessment of the Current State of the Mortgage Industry
In August 2007, a very large number of mortgage brokers and lenders
began to close parts of their operations and several shut down operations
completely. The purpose of this document is to review the points of failure,
potential points of future failure and next steps broker/owners may want to
consider to make the best of this historic market.
The Symptoms of the Credit Crunch
In August 2007, each day that goes by we are inundated with more news on the “Credit Crunch.”
* Problems with existing subprime loans. Mainly ARM, stated income, home equity
(prime and subprime) and “exotic” products such as option ARMs.
* Problems and failures experienced with mortgage-backed security investors such as
hedge funds and foreign banks.
* Tightening of credit/underwriting policies reducing the types of loans that are made to
* Movement on non-conventional mortgage rates is disconnected from the Fed interest
rate due to investor liquidity problems and low risk tolerance.
* Growing number of mortgage lenders and brokers are either shutting down parts of
operations or going out of business.
* Increasing cost of warehouse lines and warehouse lending capital requirements.
To understand the current state of the mortgage industry, it is important to first understand the
players involved with the lending process. These are also the “dominoes” – points of potential
How did this Happen?
First the Players – the “Dominoes”
Institutional and secondary market investors of Mortgage Backed Securities (MBS) are at the
head of the chain that helped raise homeownership to nearly 7o percent in the United States.
MBSs are pools of similar mortgage loans (similar credit quality, interest rate, and loan terms)
that have been turned into an investment product like a stock or mutual fund. MBSs are sold to
institutional investors who in turn sell to investors in the secondary market. The return received
by investors is dependent upon the borrower making their mortgage payments and not paying
off too fast.
Institutional investors include companies like Wall Street firms and foreign investors that buy
and hold MBS’ and in turn sell them to the secondary market. Secondary market investors are
individuals and corporate investors like companies, pension funds and hedge funds.
Next in line are Government Sponsored Entities (GSE) – like Fannie Mae, Freddie Mac and
private conduits like GMAC-RFC and large banks that buy mortgage loans from various brokers
and lenders, “package” them into MBS mortgage pools and find institutional investors to
Next are the Mortgage Lenders that lend directly to homebuyers and/or lend funds via
warehouse lines to correspondent lenders and mortgage brokers that in turn lend to
· Correspondent Lenders: Typically have capital to make loans, but access to capital for more
loans is dependent upon other large lenders or conduits to purchase their loans. They
conduct their own underwriting and sell loans after close.
· Mortgage Brokers (Wholesale Funding): Typically rely on other lenders for the capital to
make loans and will not make a loan unless another lender has previously agreed to
purchase the loan. Underwriting is conducted by the lender purchasing the loan.
In a market that has reduced liquidity, lenders dependent on “other peoples’ money” are at risk.
Last are the homebuyers that drive the demand for mortgage loans to purchase homes and take
out home equity lines for home improvements and other personal credit needs. Confidence in
their ability to pay back their mortgage debt drives the mortgage-backed security market.
Over the past three years there was a large percentage of ARM mortgage loan products made to
subprime and prime borrowers. Use of these products varies by market, but leading the pack
are markets that have higher home prices, for example California, where over 20 percent of all
ARM products in the United States have been originated. Nationwide it is estimated ARM
products accounted for upwards 60 percent of the market in 2006.
How Did This Happen and
What’s Going to Happen Next?
To understand how we are in our current state and what might happen next, we need to follow
the funds flow. As one domino falls, where one part of the chain is affected, one can see the
impact reverberate across the other dominoes, ultimately reaching the homebuyer.
The chart below depicts the interdependencies in the mortgage lending process. Funds/liquidity
begins from the left with investors’ willingness to purchase MBS. They bring liquidity to the
conduits which provide the conduits the funds necessary to buy loans from lenders and in part
give liquidity to larger lenders for the warehouse lines that bring liquidity to the mortgage
brokers and correspondent lenders. Ultimately, the funds flow reaches the homebuyers who in
turn make payments on their mortgage notes which completes the circle back to the investors by
bringing the investors their return on investment.
The next few charts outline the dominoes that have fallen as of August 15, 2007.
Impact of the Tipping Dominoes
What happens next is uncertain. There are a number of factors that will influence the outcome
and there is great uncertainty about how much damage has been or will be done to the mortgage
system in the United States.
One thing is certain and that is a “flight to quality.” For example, if you are an investor, you will
move funds towards direct origination sources such as large lenders and banks that originate
directly to the consumer versus third party originators such as wholesale and correspondent
lenders. This tips the favor and emphasis towards bank or bank-affiliated retail mortgage
If liquidity issues persist, there could be an impact on home prices, especially those over
$500,000. The growth and stability of real estate brokerage firms may well be dependent upon
access to viable mortgage lenders that will commit to funding loans – and your ability to keep
your agents and clients calm and confident. In troubling times there is always an opportunity
for the strongest brands to make the most of the environment.
Real Estate Broker/Owners and Agents
10 Ideas for Making the Best of It
1. The industry will be chaotic at least until January 2008. Be proactive to make sure your clients
have access to reliable lending. Know your client’s lenders.
2. Recommend buyers use large, stable bank-backed lenders known to be in mortgage lending for
the long haul and have a diversified portfolio of non-mortgage business.
· Hopefully you have a relationship with one of these. If not, consider it – or know where
your lender’s funding comes from.
· Integrate pre-approval requirements into your buyer and seller agreements.
3. Focus marketing on prime buyers and homes that will draw these buyers. Jumbo homes may be
hard to find financing for. Use this opportunity to get creative in helping sellers
products and to provide temporary solutions like executive rental/housing.
4. Prepare clients for potential appraisal problems as housing prices drop and lenders are more
conservative. Consider alternative ways to bring value to clients beyond home price.
5. Be ready for investors to return to the market once prices drop. Consider improving search
capabilities to help second homebuyers search nationwide or in your market for homes and for
investors to find great values.
6. Before making tough decisions, be sure to include in your review of agent and office profitability
an analysis looking across all of your services – not just real estate production.
7. Be prepared to take advantage of the foreclosure market. Look for unique ways to market as the
typical “subprime” buyers will no longer be the target buyers.
8. Now is the time to check into how you can use online marketing to your advantage to bring in the
right home sellers and buyers. At Inman’s 2007 fall convention one of Trulia’s VPs published the
“Top 50 ways to Market Online.”
9. Use your direct messaging to your agents and indirect agent messaging via your managing
brokers and office managers to keep everyone calm.
· Example: Create scripting for your agents on how they should respond to client questions
when they call about whether or not they can qualify – AND – when they call with issues
about an existing loan. Now is the time for everyone to pull together with a consistent,
constructive message to avoid class action lawsuits.
10. Agents will continue to leave the industry. Focus on increasing individual agent productivity by
leveraging your entire family of services.
(if you email me I will send you the PDF file, I could not figure out how to post a PDF file on AR)
Best regards, Charles