How to Prevent the Next Mortgage Boom and Bust
After 30 years of following the roller coaster ups and downs of the mortgage business, I'm finally feeling sick to the stomach.
Booms and busts are exciting, and they're good content for the news media as well, which is probably why I haven’t objected to them until now. But a lot of people get hurt every time the trick cigar blows up in their faces—and not just industry people. This last time, borrowers got burned, too, big time.
Does the mortgage-making rhythm always have to be so boom and bust? Barring Dramamine, isn't there some way to smooth out the industry's bipolar trajectory? Is there any way to lessen the pain of the cycles?
Obviously, the mortgage business will always be cyclical to some extent, just as the general economy is always cyclical. But this industry takes it to the extreme.
The most obvious outcome of volatility is all the lost jobs. According to the Bureau of Labor Statistics, which tracks mortgage employment, the business currently is at 291,000 employees. (That's about the population of St. Paul, Minn.) At its peak, there were more than 500,000 mortgage workers (about the size of Fresno, Calif.). At the most recent nadir, there were fewer than 250,000. That's a haircut of more than 50%. Ouch.
Now, some of those vanished workers deserved to be shown the door. But my sense is the vast majority did not. They got caught in the boom/bust whiplash. While this retrenchment is the largest, the cycle has played out many times in the past three decades.
The only conclusion: the mortgage industry is a business that eats its young. And that's not good.
What's the net effect of massive layouts? There is a lot of lost wisdom that might be used to prevent the next huge bust. Negative amortization mortgages were a big factor in the thrift bust of a generation ago, for instance, but despite this were trotted out again and helped cause the huge crater of the last decade.
Why were they trotted out again? I'll bet a lot of it was by people who didn't have the benefit of the knowledge of those who got washed out over the years.
Jay Brinkmann, former chief economist for the Mortgage Bankers Association, doesn't quite agree with me on this one. "Younger employees make small mistakes," he says. "They grow up to make bigger mistakes."
Lending attitudes can also be changed. The right balance is somewhere between the pulse loan (as in "anyone with a pulse can qualify") and the denied! stamp, but should probably lean toward more diligent underwriting. As American Enterprise Institute resident fellow Alex Pollock writes in his elegant book "Boom & Bust": "It is the professional duty of bankers and debt investors to be skeptical, not optimistic, but this seems to be forgotten in each financial cycle."
Brinkmann does agree with me on this point. "The problem is not so much loosening credit at the margins but when you open up entire areas of credit to people who would not have qualified in the past." And he points not to the obvious culprit, subprime lenders, but rather the alternative-A lenders that relied on stated income loans (the so-called liar loans).
So how can you avoid the vast influx and exodus of mortgage people every time rates fall or rise? The truth is that the booms and busts come from the great refinancing waves. So, strengthening the purchase part of the business would help. Over decades (but not during or since the Great Recession) the purchase mortgage market provided the firm foundation for the business, while refis varied from boom to bust above the purchase trendline.
Am I advocating the business to ignore refis when demand for them is high? Of course not. But mostly refi markets (such as we’ve seen over the past couple of years) are out of balance. Too much candy will make a child sick. I'm just saying the mortgage business should plan based on developing a solid purchase platform, and hope to get a little candy on the side.
Knowing what interest rates will do would be a good strategy. OK, I'm joking, though the Fed actually has been pretty transparent on rates since the recession.
What about having an industry standard that mortgages are tied to—say, to an index that isn’t very volatile? The COFI Index, for instance, is a slow moving vehicle that lags the market both on the up and down side. Digging way back into my memory I recall the California variable-rate mortgage, a precursor of the adjustable-rate mortgage. It could move at most 25 basis points per quarter. It may not be the perfect vehicle. Perhaps a better one could be devised.
Brinkmann doesn't quite agree with me on this one, either. He says you could build a structure where borrowers pay a premium for upside protection, but it wouldn’t be much comfort to investors whose cost of funds may be pegged to another source.
And what about eliminating the national debt? Wouldn't that make Treasuries (which fixed-rate mortgages are priced from) scarcer, increasing demand, boosting price and (most importantly) causing yields to fall?
"Absolutely right," Brinkmann says, adding mortgage securities could become a replacement vehicle for Treasury investors.
Ironing out the highs and lows of the boom and bust cycles? That would be dramatic. Paying down the national debt? Now that’s a truly dizzying prospect.
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.