Private-mortgage market nears unraveling, undoing decade of work

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The nascent market for private U.S. mortgages is teetering on the brink of collapse as the coronavirus crisis imperils years of work to lessen the government's role in home lending.

Several firms that issue mortgage bonds without federal guarantees have laid off most of their staffs and stopped doing business as the economy grinds to a halt. And the once-burgeoning market for securities that shift risk from government-backed agencies to private investors has also stalled, with some traders saying they've had trouble even getting prices.

Unlike in the 2008 financial crisis, mortgages are collateral damage rather than the central cause of economic distress. But the pandemic has increased the housing market’s reliance on U.S. support and threatens to have lasting ramifications on efforts to protect taxpayers from the risk of a housing downturn. The upheaval calls into question how much Washington can truly back away from a sector that amounts to a fifth of the nation’s economy.

Between February and March the volume of loans sold on Maxex, an exchange that lets lenders sell mortgages to investors like Goldman Sachs Group Inc. and Metlife Inc., dropped by 45% to about $600 million, said Maxex President Bill Decker. He said investors who borrow money to buy mortgages, like real-estate investment trusts, have sharply pulled back and may never return if the distress lasts too long.

"It's OK to prune the bush, but if you cut it back too hard, it doesn’t come back at all," said Decker, whose exchange deals mostly with jumbo mortgages that have high balances and no government backing.

In 2019, private-label securities represented merely $46 billion of the $2.38 trillion in mortgages issued, according to the Urban Institute, a Washington-based policy research organization. Portfolio loans that aren't securitized and also don’t have government backing made up another $853 billion.

The 2008 crisis obliterated investor appetite for mortgage-credit risk, leaving the burden almost entirely on federal entities like Ginnie Mae or government-supported companies like Fannie Mae and Freddie Mac. Private mortgage bonds, which made up more than 40% of the market in 2006, had virtually disappeared by 2009.

The Treasury Department, starting with the Obama administration and continuing under President Trump, has worked to revive at least some semblance of a private market. They have convened lenders, investors and mortgage servicers in a series of efforts to repair trust and create potential new securitization structures.

Treasury has also encouraged the development of new securities sold by Fannie and Freddie to offload credit risk to private investors. Those primarily consisted of credit-risk transfer securities, a form of debt whose returns depend on the performance of underlying pools of mortgages.

The government's goal wasn't to return to the risky lending of the past but to ensure that private investors rather than taxpayers would take losses in a housing downturn. Certain kinds of borrowers, like the self-employed, often don't qualify for government mortgage programs. Officials hoped a revived private market could take care of such consumers.

Many of the companies that led growth in privately-backed mortgages aren't doing business at all right now. Angel Oak Mortgage Solutions, which specializes in loans not backed by the government, cut 70% of its workforce. Deephaven Mortgage, which does the same, said on its website that it had suspended all loan applications, closings and funding "due to extreme market volatility." Citadel Servicing Corp. also said it would stop making new mortgages for a month.

Part of the problem for private mortgage lenders is that their own banks, which give them short-term loans to fund mortgages, either cut their credit lines or made them significantly more expensive.

Without some sort of fix to keep the private market functioning, "it seems like you run the risk of turning back the clock on the private market for credit risk and undoing much of what's happened over the last six or seven years," said Jim Parrott, who served as a senior housing adviser to President Barack Obama and is now a consultant to lenders, investors and other mortgage-market participants.

So far, the government has been reluctant to help. Industry groups lobbied to make high-quality private mortgage bonds eligible for the Term Asset-Backed Securities Loan Facility, which would let issuers pledge bonds in exchange for short-term loans. But the Federal Reserve didn't include private residential mortgage bonds when it announced an expansion of the program last week.

Some credit-risk transfer security investors have also lobbied the Federal Housing Finance Agency, which oversees Fannie and Freddie, to let the mortgage giants either buy back some of the securities at a discount or establish their own short-term lending facilities, according to one investor who requested anonymity to discuss the private conversations.

The investor acknowledged that such a move could seem counter to the point of transferring risk, which was to have private investors bear the risk of losses in downturns. But the person said the market is still so nascent and relatively illiquid that this crunch could drive some investors away permanently.

On top of that, some owners of private mortgage bonds say that they feel pressure to provide relief to homeowners. Congress passed a law requiring servicers to let borrowers delay payments on government-backed loans for as long as a year, but some lawmakers and affordable-housing advocates say the relief should extend to private mortgages as well. Unlike with government-backed loans, the investors would bear potential losses.

"I would not want to be in front of some members of Congress during a hearing to explain why I withheld the kind of forbearance that peers are providing," said Eric Kaplan, a director at the Milken Institute's Center for Financial Markets.

Of the private mortgage market, Kaplan said, "Right now, this is an exercise in getting to the other side and getting to the other side with as little damage as possible."

Bloomberg News