So Much Is Upside Down in the Mortgage Industry Right Now
One of the biggest anomalies I've seen in 30 years of observing the mortgage business is the current inversion of jumbo and conforming rates. But there are other anomalies you can see in the business if you look closely.
Jumbo mortgages, which normally have higher yields than agency products, dropped lower than conforming mortgage yields around Thanksgiving. According to the most recent survey by the Mortgage Bankers Association, the inversion last week was five basis points (4.45% for jumbos versus 4.5% for loans guaranteed by Fannie Mae or Freddie Mac).
I've seen several inversions of yields between the 10-year Treasury and the 30-year Treasury. These happen every few years and generate a lot of head-scratching. But I can't recall a sustained jumbo inversion before. What's going on?
Conventional mortgages, the conventional wisdom goes, should be cheaper than jumbos (those larger than the conforming loan limit) because the net effect of the government-sponsored enterprises is to buy down interest rates for consumers by a number historically believed to be about 25 basis points.
At National Mortgage News, we've reported that one of the key factors in the inversion is lenders' reaction to GSE guarantee fees, which have been steadily increasing since the crisis. That could make the lower jumbo yields attractive to lenders, if the costs to make the loan are even lower.
It is still a strange effect, however. If public policy is for the GSEs to buy down rates for lower-end consumers so they're lower than for those who can afford pricier homes, it isn't working just now. But before I advocate the agencies abandon their current niche and supply consumers with lower-cost jumbos, I realize that would be an even bigger inversion that will probably never happen.
Alex J. Pollock, a fellow at American Enterprise Institute who has spent more than three decades in banking, including a stint as CEO at the Federal Home Loan Bank of Chicago, sees other anomalies with the agencies.
“One anomaly is that Fannie and Freddie are given a pass on the QM rules that apply to everybody else,” he says, referring to the seven-year exemption from the qualified mortgage rule for loans sold to the GSEs.
Another is that “the Fed buys only agency mortgages, providing a subsidy for them but for nobody else. Where would Fannie and Freddie mortgage-backed securities be trading if not for the Big Bid of the Fed? Both of these government actions increase Fannie and Freddie's market share and profits.”
There have been a number of anomalies in the business, perhaps not a surprise considering the whipsawing in the market during and after the crisis. One of my favorites is to see mortgage servicers handling origination functions. Could we see the abandonment of the two traditionally different silos at lenders in favor of a single platform?
Servicers have certainly added underwriting to their skill sets as they prudently re-underwrite mortgages for modifications. And they have added homeownership counseling to their portfolios, as well. I can remember when the proper time for homeownership counseling was before the loan closes, not after the borrower defaults!
Of course, not everything in the mortgage industry is upside down. The originations business has shifted back from the Wild West of easy underwriting and shoving risk off to the next party to something that any lender active 30 years ago would recognize. And that is a world dominated by Fannie, Freddie, Federal Housing Administration and Ginnie Mae activity, with a little lending done around the margins by "hard money" lenders. Hard money was a precursor to subprime lending but with a big difference: it was called hard money because it was hard to get, not easy. It was carefully underwritten to mitigate risk, had higher rates than agency product, and required huge down payments.
A big anomaly I noticed before the crash was that Freddie, Fannie and Ginnie were getting rather too cozy, with the GSEs investing in Ginnie Mae securities. What is the point of having separate agencies if the lines between them can get blurred by GSE shareholders' hunger for profits?
Of course the worse outcome turned out to be the agencies investing in subprime mortgage securities as a way of getting around their prohibitions against buying subprime loans. The Ginnie/agency coziness was a curiosity. The agency/subprime nexus was a calamity.
Mark Fogarty, Editor at Large at National Mortgage News, is starting a regular blog of analysis and commentary based on his 30 years covering the mortgage industry.