Expanding Private Lending- Pt 1
Many people had been effected by the housing crash and
consequent foreclosures, upside down home mortgages and financial devastation.
While there has been a lot of talk and analysis of what led to the crash and
what we can learn from it, many still don’t understand not only the interest
rates, types of loans but most importantly what actually happens when you get a
loan. Loans can be given privately and publicly and a lot of times are sold on a
Secondary market; the government does this with Fannie Mae and Freddie Mac.
While we have seen quite an up swing in the housing market and unemployment the
Dawn Thomas Team’s goal
is for our clients to know as much as they can a take control of their own
financial futures. Read on for more about lending and in what markets it’s
expanding…
“The future of Fannie Mae and Freddie Mac, the two secondary market behemoths that became wards of the federal government in September 2008, is in limbo. Virtually all politicians on the national scene would like to get rid of them, none more than their previous political champions for whom their continued presence is a source of embarrassment.
But because they purchase more than half of all new mortgages, shutting them down would cripple the mortgage market — perhaps start a second round of home-price declines. As a result, nothing is done.
While virtually everyone would like an expansion of private-sector lending that would permit a phase-out of Fannie/Freddie, there is no strategy in place to bring that about. These are three possible strategies: Expansion of portfolio lending; revival of the private secondary market that collapsed during the crisis; and development of a different type of private secondary market.
Expanding portfolio lending
When the lender who originates a loan retains it instead of selling it, we call it portfolio lending. Before World War II, virtually all mortgage lending was portfolio lending, and in most other countries this remains the case. In the U.S. today, however, only about 5 percent of new loans are retained. The lenders are depository institutions including credit unions. The rest are securitized with guarantees of the federal government.
There is no prospect that existing depository institutions in the foreseeable future will be able to expand their portfolio lending to the degree needed to offset a phase-out of Fannie and Freddie. Most of the mortgages purchased by the agencies have fixed interest rates. Even if the industry of depositories grew to twice its current size, it could not absorb these mortgages without exposing itself to the same kind of interest-rate risk that devastated the savings and loan industry in the 1980s.
In addition, the recent financial crisis demonstrated that home mortgages carry substantially more default risk than previously thought. Portfolio lenders now realize that home prices can fall as well as rise, which reduces the value of the collateral securing home mortgages. They also realize that when home prices drop in a weak economy, default rates can balloon to double digits, and they will not have the staff to acquire and dispose of collateral quickly, which further reduces collateral values. Finally, lenders are now aware that when the system is stressed, government will blame lenders for the plight of borrowers, and will intrude themselves into the collection process in numerous ways that raise lender costs.
In short, reflecting both the direct impact of the financial crisis and the punitive actions of government stimulated by the crisis, portfolio lending has become increasingly unattractive to depository institutions. The mortgages they want to hold today are primarily large ones made to existing customers.”
STAY TUNED FOR THE CONCLUSION!
Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania.
“The future of Fannie Mae and Freddie Mac, the two secondary market behemoths that became wards of the federal government in September 2008, is in limbo. Virtually all politicians on the national scene would like to get rid of them, none more than their previous political champions for whom their continued presence is a source of embarrassment.
But because they purchase more than half of all new mortgages, shutting them down would cripple the mortgage market — perhaps start a second round of home-price declines. As a result, nothing is done.
While virtually everyone would like an expansion of private-sector lending that would permit a phase-out of Fannie/Freddie, there is no strategy in place to bring that about. These are three possible strategies: Expansion of portfolio lending; revival of the private secondary market that collapsed during the crisis; and development of a different type of private secondary market.
Expanding portfolio lending
When the lender who originates a loan retains it instead of selling it, we call it portfolio lending. Before World War II, virtually all mortgage lending was portfolio lending, and in most other countries this remains the case. In the U.S. today, however, only about 5 percent of new loans are retained. The lenders are depository institutions including credit unions. The rest are securitized with guarantees of the federal government.
There is no prospect that existing depository institutions in the foreseeable future will be able to expand their portfolio lending to the degree needed to offset a phase-out of Fannie and Freddie. Most of the mortgages purchased by the agencies have fixed interest rates. Even if the industry of depositories grew to twice its current size, it could not absorb these mortgages without exposing itself to the same kind of interest-rate risk that devastated the savings and loan industry in the 1980s.
In addition, the recent financial crisis demonstrated that home mortgages carry substantially more default risk than previously thought. Portfolio lenders now realize that home prices can fall as well as rise, which reduces the value of the collateral securing home mortgages. They also realize that when home prices drop in a weak economy, default rates can balloon to double digits, and they will not have the staff to acquire and dispose of collateral quickly, which further reduces collateral values. Finally, lenders are now aware that when the system is stressed, government will blame lenders for the plight of borrowers, and will intrude themselves into the collection process in numerous ways that raise lender costs.
In short, reflecting both the direct impact of the financial crisis and the punitive actions of government stimulated by the crisis, portfolio lending has become increasingly unattractive to depository institutions. The mortgages they want to hold today are primarily large ones made to existing customers.”
STAY TUNED FOR THE CONCLUSION!
Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania.
This blog is courtesy of The Dawn Thomas Team who is an
award-winning Real Estate Agent team at Intero Real Estate Services in Los Altos
650-701-7822. We help nice people with selling and buying homes from Palo Alto
to West San Jose!
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