It's Time for the Mortgage Banking Industry to Grow Up

After World War II, the U.S. Federal Government did an incredible thing when it created the VA lending program and VA benefit for the soldiers returning from the war. The VA lending program has been highly successful public/private partnership. This program allowed mortgage bankers to essentially use the U.S. Federal government's balance sheet and AAA+ rating to offer a fully pre-payable fixed rate mortgages with high leverage. Veteran's and active-duty service members used the program to create generational wealth and family stability. The success of this program was later copied by HUD and the Federal Home Loan Banking System, which eventually led to the creation of Government Sponsored Enterprises (the GSE's) Fannie Mae, Freddie Mac, and the secondary mortgage market. Lew Ranieri and later all of Wall Street used these programs to create the most liquid market for mortgage bonds in the world. Some could argue the market grew too liquid. The human condition and propensity for greed (which is not a new problem) eventually ruled the day and led to the 2008 housing crash.

After the 2008 crash, most of the GSE's common stock was confiscated by the Federal government in a conservatorship. This was the first act of many where the Federal government took a more active role in the mortgage banking industry. There were the HARP programs, which allowed homeowners to refinance their mortgages with balances that exceeded their home's value. There were several flavors and forms of "printing money" called quantitative easing. The GSE's increased their guarantee fees and demanded up-front cash up from security issuers in the form of "loan-level price adjustments." The GSE's also increased the frequency and severity of their loan repurchase demands. There were a myriad of new regulations. Some were good like the NMLS and the AIR. Some were bad such as originator compensation, the LE, and the CD. The final act came in 2020, where we increased the number of dollars in circulation (M2 money supply) by a whopping $6T in less than a year. To put this in perspective, let's go back to 1971 when the US abandoned the gold standard. In 1971, the number of dollars in circulation was roughly $600B. The M2 money supply grew steadily over the next 35 years to "only" $8T. M2 money supply peaked at just under $22T in 2022, and we now sit at $20T thanks to the recent efforts of the Federal Reserve Bank and without interference from the current administrations in Washington.

In the years leading up to the 2008 crash, non-Agency mortgage originations and non-Agency mortgage securitizations surpassed Agency originations and securitizations. The 2008 crash crippled both of these markets and also crippled other asset-based securitization markets such as CMBS, Auto, and Credit Card. Since that time, the non-mortgage asset-based securitization markets have recovered nicely with very few losses for bond investors. In the mortgage securitization market, the exact opposite thing has happened. Agency securitizations now dominate this space like never before. Non-agency securitizations are only a small fraction of the mortgage securitization market.

It's interesting that the GSE's report quarterly earnings. These earnings are not distributed to GSE’s common shareholders and stay in Washington. The GSE's in their current form do almost nothing to: innovate, increase operational efficiencies, improve the mortgage experience for the consumer, reduce costs for the consumer, and most importantly increase home ownership. The cost to originate is as high as it's ever been. 100% of this cost is passed on to the consumer or is found on the income statements and shrinking balance sheets of most Mortgage Bankers. Additionally, the GSE's require many things that are antiquated, expensive, and no longer needed. A couple of examples:

• Title searches and inspections. These could be easily validated with the block chain.
• Use of the credit reporting cartel. A borrower's credit reputation could be easily validated for free with a peek on-line bill payments from their bank.

As long as the Mortgage Banking industry is dependent on the (mostly) federally-owned GSE's, Mortgage Banking innovation will be limited. It will be difficult to create a better consumer experience. It will be next to impossible to lower the cost to originate.

Agency securities are tied to the 10 Year US Treasury bond. Since the 2008 crash, the US 10 Year Treasury bond has yielded less than 4% and sometimes less than 1%. Part of this was a result of low inflation, but most of it was artificial and a creation of the Federal Reserve Bank who purchased many of these bonds. Low yields from Fed intervention suppressed the non-Agency mortgage securitization market. With the US Federal government annual budget at roughly 100% of GDP and very little fiscal discipline in Washington, the days of sub 4% 10-year Treasury bonds are over. Treasury yields may go even higher if we are unable to reel in the M2 money supply.

It's time for the Mortgage Banking industry to grow up and wean its dependence on the U.S. Federal government. The timing is perfect for non-agency originators and the non-agency securitization market to continue to innovate and create a sustainable mortgage product leading to a better consumer experience, lower costs to the consumer, and a higher homeownership rate.