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For signs of hope in mortgage-lending arena, look to past

Peter G. Garvin

Published September 15, 2007 at midnight

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The past 120 days in the mortgage-lending arena have been unprecedented in both the number of company closings and illiquidity in the market.

I will attempt to explain the current situation by a brief economic history coupled with a compilation of facts.

First, the 1990s proved to be a time of fairly stable long-term interest rates in the mortgage lending business. Following this, there came a period when Washington, D.C., began to promote the idea of homeownership for everyone. This promotion was directed from the White House as well as Congress. In response to this new challenge, Realtors, home builders and mortgage lenders alike looked to the secondary markets to assist with supplying the ever-increasing capital demand for housing.

The secondary markets began to provide the liquidity for high-rated mortgage-backed securities; many new products were developed as a mechanism to provide financing to homeowners. These products included one-, three- and six-month interest-only adjustable products, negative amortization loans, payment abatement programs and 100 percent-plus financing vehicles. In addition, the "subprime' (less than prime-grade loans) and "Alt-A" (in between subprime and prime-grade loans) began to draw the attention of Wall Street. New programs were developed to purchase MBSes with these products as collateral, similar to the packaging of prime loans.

Before anyone starts pointing fingers and saying "the lenders are to blame" or "Wall Street is to blame," we need to understand the frenzy that was taking place. The market for residential sales was as hot as it had ever been. New construction pricing was rising at 30 percent to 40 percent per year in some areas of the country and the resale market was close behind. The financial markets were clamoring for more and more MBSes because of their high ratings; the amount of capital being directed toward housing was phenomenal. The bond ratings became better and better; most were being graded as triple-A" investment products.

Then problems started. The residential market slowed and values began to stagnate. Borrowers were just starting to feel the pain associated with the adjustments in their mortgage loans, and many were not able to meet the higher payments. The result was an increasing number of defaults and foreclosures.

Suddenly, the robust residential market was not so robust, and the torrid pace of sales began to slow considerably.

Many of the loans made with "no-down" and below-market financing with "teaser rates" were experiencing their first adjustments upward. Initially, the subprime market felt the affects. The number of "first-month lates" began to climb, and the ratings of the MBSes associated with these loans began to fall. Suddenly Wall Street was not so enamored with MBSes; the huge amount of capital funneling to these investments began to fall. The secondary market (where mortgage bankers sell their loans) began to balk at pricing and value of these MBSes. Once that occurred, money moved to other investments that were viewed as safer and holding their value.

The lack of money to purchase pools of mortgage loans then had the ripple effect in the shorter-term lines of credit that mortgage bankers use to close and fund loans. Once these lines became tougher to obtain, we experienced what the industry and news media have been referring to as the "liquidity crisis" - a true inability of mortgage bankers to locate lenders willing to extend short-term lines of credit to fund their loan closings.

That gets us to where we are today. The equity market has gotten clobbered. Mortgage stocks fell quickly and many mortgage companies have gone out of business. Tens of thousands of people have lost their jobs, and investors have lost hundreds of millions of dollars in all of this.

The mortgage industry, home-building arena - and residential real estate as a whole - is a cyclical business. It ebbs and flows. Interest rates move in both directions, and we feel the effects of those movements, good and bad. We have just experienced the longest economic expansion in the history of our industries. The housing industry had an eight- to 10-year run of phenomenal revenues and profits. What goes up must come down.

We will return to a period of normalcy and the markets will stabilize. The residential real estate market will rebound, the liquidity issues will diminish, and we will return to a better market, but it will take some time. Slowly but surely the private sector will pull together and the markets will improve, just as they have in the past.

Peter G. Garvin, a graduate of the College of Real Estate at the University of Denver, is a 30-year veteran of the mortgage banking industry.

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