The 'Invisible' Mortgage Banker: Wall Street

Thanks to all those TV commercials as well as big full-page ads in The Wall Street Journal and The New York Times, some consumers actually have a vague idea that Fannie Mae and Freddie Mac play a role in the mortgage market - providing liquidity to thousands of lenders.

Most consumers, though, probably don't realize that the GSEs only play a role in the conventional market, eschewing - for the most part - subprime, no-downpayment loans and other nonconforming products. As the industry well knows, Fannie and Freddie buy some nonconforming loans, but less face it - their volumes in these niches are paltry.

Indeed, Fannie and Freddie are the "invisible men" of the mortgage industry. The only time they get much press outside of the business pages is when a scandal darkens their doorway, as it has the past 18 months. Each GSE has seen its reputation harmed by huge accounting blunders. Freddie was making so much money that its top brass felt it had to save some ($5 billion) for a rainy day. Fannie had a slightly different problem: it thought it could delay $9 billion in impairment charges that it should've been taking.

Both GSEs got their knuckles wrapped but good and their top executives were tossed overboard. By the fall '05 Congress is expected to pass legislation, creating a regulator that can actually sue the GSEs in Civil Court, a regulator that won't have to beg Congress for money when the need arises.

That's all well and good. Companies as large as Fannie and Freddie ($1.5 trillion in on-balance sheet assets) need a real regulator. But what about Wall Street - the other "invisible" man of the mortgage industry? Huh? That's right - Wall Street, those firms south of Canal Street that have huge mortgage conduits, conduits that (intentionally?) operate behind the scenes, buying and securitizing all those wild-and-crazy loans that the GSEs won't touch.

Who am I talking about here? Let's name names: Bear Stearns, CSFB, Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley. I'm sure I've left a few firms off the list and for that I apologize. Yes, all these powerhouse of finance are now key and very important players in the residential mortgage market - but Main Street USA doesn't know it.

Why are Joe and Josephine Six-Pack in the dark? Well, for one, the Street generally doesn't table-fund loans, instead it does what the GSEs do - it buys closed loans, its favorite product being "alt-A" and subprime loans, not to mention the red-hot "interest-only" loans. (Some Street firms, such as CSFB, actually table-fund loans through brokers.)

Yes, Wall Street is invisible when it comes to mortgage banking, but is that a good thing? It's hard to say. I'm not a conspiracy theorist but I think Wall Street wants to be invisible. The last thing a blueblood investment banker wants is some consumer activist or pesky class-action attorney sniffing around its mortgage business.

Quite a few Wall Street firms (Lehman, Merrill, to name two) have been in the mortgage business for ages. Lehman, of course, owns Aurora Loan Services, the huge, Colorado-based alt-A lender. Lehman also owns stakes in BNC Mortgage and Finance America. You may notice that none of its mortgage companies carry the Lehman name.

Another thing the Street wants to avoid is having a retail presence in mortgages. Why? Because Street folks tend to be highly educated and they know retail involves having a ton of fixed costs, bothersome employees who want bothersome benefits and who will need to be fired when volumes slow.

This is how the conduits operate: they have trading desks and executives whose job it is to accumulate loans. The Street outsources most of its underwriting, usually to third-party contractors like the good folks at Clayton. They gather product and they securitize. They also offer warehouse funding.

But whose watching the Street? Where's their regulator? The SEC? There's an emerging school of thought out there that all these wild-and-crazy nonconforming loan products - which provide lower "teaser" payments - are partly responsible for driving up home prices. When the housing bubble bursts in some markets, will Wall Street get tarred and feathered? Should they?

Paul Muolo is executive editor of both Mortgage Servicing News and National Mortgage News. He can be e-mailed at Paul.MuoloThomsonMedia.com.

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