In the days leading up to a US presidential election, it is popular to write long and detailed analyzes of how the election will affect one industry or another. In the mortgage industry, concerns about how to deal with COVID and the CARES law pale in comparison to mere political considerations.
How do we solve millions of criminal mortgages due to COVID is the only question that matters. You will remember in March and April we shouted that many mortgage lenders were on the verge of failure. The Federal Open Market Committee's decision to "make it big" with purchases of mortgage-backed securities from the US Treasury Department and free market agencies nearly led to the failure of several large, publicly traded hybrid REITs and mortgage lenders.
We must remember that April and May margin calls for the to-be-announced market of half a trillion dollars a month were more than the net worth of the entire industry. We fixed this issue in June when volumes increased and margins were returned by TBA traders. The industry and regulators, however, are borrowing from bond investors to help lower the cost of forbearance under the CARES Act. This is not a long-term solution.
With the CARES Act, Congress unilaterally imposed costs on mortgage servicers and other lenders with no consideration of compensation. State governments have also imposed moratoriums on auto and trade loans. Congress and states need to remedy this deliberate act of omission before the refinancing wave subsides and the mortgage industry faces another liquidity crisis due to the CARES act and the unfunded moratoria on consumer payments at the state level.
So far, the industry has used the trust deed generated by the FOMC's low interest rates and the resulting increase in paper loan volumes over the cost of COVID. As we noted in The Institutional Risk Analyst, the industry will continue to use the float of mortgage prepayments and repayments to fund CARES Act advances as long as mortgage refinancing volumes remain high.
However, the liquidity that so conveniently comes from loan repayments and insurance claims belongs to the bondholders. Servicers can deposit this cash with a bank for about a month when it is issued to MBS holders. The point is, mortgage lenders and service providers will ultimately have to replace such trust funds in order to make payments to bondholders in relation to such prepayments and mortgage disbursements.
If the flood of mortgage refinancing volumes subsides, the industry's funding needs will grow significantly and as quickly as they disappeared in May and June of this year. Smart investors noted in some of the most recent public stock offerings that bank loan drawdowns from several independent mortgage lenders seemed a little low – too low.
As liquidity increases, the industry will draw on bank storage and non-bank repurchase facilities for additional cash. The FOMC will no doubt respond again with major purchases of mortgage-backed securities in the open market.
Ultimately, however, to avoid disaster, Congress must do two things: 1) Authorize the Federal Reserve System to fund the CARES Act advances through warehouse lender banks. This is the plan suggested by former Ginnie Mae boss Ted Tozer. And 2) Congress must authorize the FHA to fully reimburse the advances and other expenses of the CARES Act. Problem solved.
When the year ends and begins 2021, mortgage investors will have to decide whether to keep dropping the mortgage servicing rights market. How Congress resolves the mess they created with the CARES bill will be a crucial determinant. With the FOMC imposing negative effective returns on global MBS investors due to the high prepayment rate, the industry no longer needs such help from Washington.
If Congress succeeds in resolving the CARES Act indulgence mess, this will be good news for banks, IMBs, and also the GSEs, Fannie Mae and Freddie Mac, who should also be reimbursed for the cost of financing missed loan payments and other expenses . As FHFA Director Mark Calabria told Congress earlier this year, if you don't like the fee increases, you should fund the COVID-related expenses.
We hear that House Financial Services Chairman Maxine Waters appreciates that Congress left many unfinished businesses in passing the CARES bill and promptly left town to avoid the risk of COVID. But unless Congress acts to fix the chaos in the CARES bill that started six months ago, 2021 could indeed be a very bad year for the mortgage industry.
For both investors and risk professionals involved in the secondary mortgage market, the next few years are associated with both great opportunities and considerable risks. "We have no problem getting capital into the MSR asset. The biggest problem is speed," said Matt Maurer of SitusAMC at the IMN MSR conference in New York last week. Another sharp, sudden drop in interest rates from the FOMC could mean another wave of margin calls, prepayments and losses for investors and IMBs.
The good news is that investors like REITs and private equity funds have raised cash and are once again supporting the secondary mortgage market for conventional and government loans, MBS and MSRs. However, if we do not address the shortcomings of the CARES Act soon, the liquidity in the secondary mortgage market could disappear again. In this case we go straight back to the situation that existed in May of this year with no secondary market liquidity.
So don't ask about the 2020 elections or who will be in the White House next year. It doesn't matter in the grand scheme. The outlook for mortgage production in 2021 is the central question facing policy makers at the Fed and mortgage agencies like HUD, Ginnie Mae, and the Federal Housing Finance Authority. And how and when Congress and states fund consumer credit indulgence could determine the fate of the entire industry and the US economy.