Coronavirus poses new threat to mortgage industry

A flood of missed home-loan payments caused by the coronavirus outbreak is threatening to bankrupt U.S. mortgage lenders and deepen the economic toll of the pandemic.

Grueling business closures and social restrictions imposed to slow the pandemic have left millions of homeowners jobless and short on their mortgages.

The economic rescue package signed by President Trump on Friday allows any homeowner with a federally backed home loan facing financial hardship because of the pandemic to apply for 180 days of loan forbearance. That means payments on a substantial portion of the $7 trillion in federally guaranteed mortgages could stop for at least six months, leaving the government and mortgage servicers on the hook for billions in losses.

Industry advocates warn that without a federal intervention, an extended downturn could set off a chain of economic and financial crises akin to the 2007-08 panic and recession. Without a steady stream of mortgage payments, servicers will be unable to pay investors who purchased bonds funded by the revenue from thousands of mortgages packaged together.

“There have been plenty of natural disasters where this system performs well,” said Mike Fratantoni, chief economist at the Mortgage Bankers Association. “But it wasn’t designed for something like this. Nothing could be, I don’t think.”

“This really is a national-scale emergency,” he added.

Fratantoni projected that if one-quarter of U.S. homeowners — about 12.5 million households — seek forbearance for six months, servicers could owe between $75 and $100 billion to investors.

Allowing the mortgage industry to crumble could trigger another devastating cycle of foreclosures and bond market crises as investments seen as safe fall apart under an unprecedented financial shock.

The coronavirus pandemic also threatens to reopen the long debate over the mortgage industry and the reforms instituted after the last financial crisis.

Supporters of stricter financial rules who have long called for greater oversight of the mortgage industry insist that federal support this time must come with restrictions to prevent a similar crisis from happening again.

“I would not necessarily be opposed to providing them with liquidity from the Fed if we have to do that,” said Amanda Fischer, policy director at the Washington Center for Equitable Growth, a progressive think tank. “But it needs to come with some sort of more durable reform.”

“Mortgages are going to be more expensive, but the upside of that is that we’re not going to be flailing about during times of crisis,” Fischer said, adding that changing the ways mortgage servicers make money are crucial to reforming the system.

After the collapse of the housing industry triggered a credit crunch in 2007, the federal government imposed strict oversight on nationally chartered banks and a slew of new mortgage regulations designed to protect homeowners from the predatory home loans that fueled the crisis.

The losses will pose severe challenges for the Federal Housing Finance Agency (FHFA), the regulator and conservator of Fannie Mae and Freddie Mac, which are responsible for guaranteeing and securitizing trillions in home loans to keep credit flowing and affordable mortgages available.

“If this is a short-term event — say six to eight weeks — we believe that Fannie and Freddie and the servicers are equipped financially to be able to get through this time,” said FHFA Director Mark Calabria in a CNBC interview last week.

But Calabria also warned of the dangers of a prolonged economic slump.

“If this goes beyond that, then we may be having to look for public assistance,” he warned.

On Sunday, President Trump, who had floated reopening the economy by Easter, instead backtracked and said he would keep federal guidelines on social distancing in place through April.

And as the pandemic persists, industry groups are likely to keep pushing for help in subsequent stimulus packages, with lawmakers on Capitol Hill already working on additional help for American workers and businesses.

In many ways, the coronavirus crisis will pose new questions for the mortgage industry from the 2007 crisis.

In particular, the tightening of bank oversight helped foster the growth of nonbank mortgage lenders, who are not required to hold the same levels of capital to backstop losses during a crisis.

The nonbank mortgage industry dramatically expanded while low interest rates and a rebounding economy helped drive housing prices to new heights and fuel a reemergence of mortgage-backed securities.

“There was definitely a shift where the banks decided it wasn’t as economical for them because it’s a low-margin, high-volume business in the best of times,” said Graham Steele, former chief Democratic counsel on the Senate Banking Committee.

“And it just felt like the economics didn’t work well for the banks, and so you had nonbank servicers step in because it’s a little more economical for them.”

The sudden collapse of the economy is a particularly daunting first test for many firms who’ve only known the boom of the post-recession recovery.

“The level of potential non-payment in April due to the pandemic (and potentially beyond) could quickly exhaust their cash reserves and send them into bankruptcy. This could produce a tsunami of illiquidity,” wrote Beacon Policy Advisors, a Washington research consultancy, in a Monday note to clients.

Updated on Wed. April 1 to clarify the purpose of the FHFA.