Will Congress Take Actions To Stem ALL Potential Mortgage Defaults?

The United States, along with nearly every other country in the world, is coming to grips with one of the worst crises since the Second World War as it tries to both limit the spread of the Coronavirus and keep the economy from collapsing while its citizenry quarantines in their homes.

As Congress hastily works with the administration to pass another stimulus package, one thing it hopes to achieve is to ensure that as many people as possible can retain ownership of their homes as their incomes plummet and mortgage payments become more difficult to make.

Of course, the 2008 recession is still fresh in people’s minds. The near collapse of the global financial sector precipitated a massive taxpayer-funded bailout for big banks, but one unavoidable outcome was that it also made it more expensive for lenders to do business in the United States. 

Two years later Congress passed Dodd-Frank, which—among other things—served to restrict access to credit for many Americans with less than stellar credit scores; in some communities—like my hometown of Peoria—no bank would issue a mortgage that it could not sell to Fannie Mae or Freddie Mac. 

Into this void stepped a variety of non-depository lenders to provide mortgages. Such institutions now issue a majority of all mortgages. Their solvency will affect the depth of the recession and also the extent to which it impacts middle class homeowners. 

The CARES Act—passed by the Senate early Wednesday morning and scheduled to go before the House on Friday—does several things to help middle class households who suddenly find themselves without a job, such as delaying tax filings for three months and expanding unemployment benefits. 

However, the bill does not directly address the problem of families who may suddenly find it difficult to make their mortgage payments. It is easy to understand why it does not—no one has yet missed a monthly paycheck so there is no perceived urgency, and the commercial banking industry appears to be in fine shape and holds few mortgages. However, the mortgage-backed securities market clearly recognizes the eventuality of sharply higher mortgage defaults, judging by its astounding volatility in the last couple of weeks. 

Making a provision for some sort of forbearance—the ability to temporarily reduce or pause their monthly mortgage payments—and providing liquidity to non-depository lenders would go a long way towards easing middle-America’s financial angst and mitigate a potential crisis in financial markets.

Non-depository lenders fund their loans not with money in savings accounts but by selling securities or other policies to the public.  If their mortgagees begin missing payments it will compromise the ability of non-depository lenders to pay back their lenders: providing them access to liquidity would help prevent a collapse of the industry and a recurrence of 2008. The Federal Reserve has been doing yeoman’s work in supplying liquidity across financial markets, but that may not be sufficient if we start to see families become unable to make their mortgage payments.

While offering forbearance to mortgage holders makes sense given the current state of the economy, it would still leave mortgage lenders on the hook to pay their lenders with less cash coming in. Companies like New American Funding and LenderFi lack the liquidity to offer borrowers forbearance – especially for a potentially extended and uncertain period of time. This is important because the people who borrow from independent mortgage lenders are much more likely to become unable to make their monthly mortgage payments.  

While borrowers from big banks are typically more financially stable and have less risk, nonbank mortgage providers market predominantly to first-time homebuyers and Americans with lower credit scores. The fact that banks are currently in relatively good shape and not in dire need of financial assistance obscures the reality that non-depository lenders may soon need help. 

Draft legislation before Congress currently would provide support of forbearance only for “insured, depository institutions, bank holding company, or any affiliate thereof,” with non-depository lenders notably absent in this plan. Expanding it to include non-depository lenders would allow the borrowers most in need to benefit from such a plan and achieve its ostensible goal—to reduce the amount of home foreclosures and stabilize financial markets. 

Like it or not, a growing number of households get their mortgages from nonbanks. If Congress fails to extend to them some sort of forbearance relief, much of the nonbank mortgage world will disappear, not only leaving (unnecessarily) a financial mess but also destroying most of the industry. Given that home ownership rates remain below where they were a quarter-century ago, perhaps Congress should aim for a gradual diminution of the industry’s role in mortgage issuance if that is its intent, but after the current crisis has eased. 

While it may be a long-term goal to rein in the nonbank sector and put it under stricter oversight, now would be a bad time to try to put the genie back in the bottle.