By Roy C. Smith
While
the corporate side of global finance is recovering well, another side that
suffered in the crisis is still ailing so badly it is a drag on the US economic
recovery as a whole. Mortgage-backed securities may have got a bad name in
2007-2008, but some way to revive the structured finance market must be devised
to get the housing market out of the doldrums.
Corporations around the world issued
$2.1 trillion dollars of new bonds in the first half of this year, according to
Dealogic, setting a record. The issues included corporate investment
grade, high yield and financial industry bonds. Corporate new issues of stock
(including a big increase in IPOs) also increased over the first half of 2013,
to $489 billion, a 20% improvement. So global capital markets are on
track to provide about $5 trillion of corporate finance in 2014.
Banks also provide global syndicated
loan facilities (including bridge and other leveraged loans, and refinancing)
to corporate clients. For the first half, the volume of all such loans was $1.7
trillion, up 8% on 2013 and the highest since 2007.
The main difference in capital market
activity since the crisis, however, has been the plunge in global “structured
finance” (securitised debt). In 2006, $2.8 trillion of global structured
finance issues were sold. By 2013, volume had dropped 70% from its peak,
to $790 billion, and at a pace of $356 billion in the first half of 2014, it
appears to be drifting even lower. Most of the decline in structured finance
has been in mortgage-backed securities, especially those issued without US
federal agency guarantees.
In the US, banks make mortgage loans
based on credit scores, then sell the loans to federal housing finance agencies
(the Federal National Mortgage Association, Fannie Mae, or the
or
Federal Home Loan Mortgage
Corporation, Freddie Mac) that guarantee the loans and package them into
mortgage-backed securities to be sold to the market. The banks recover
their investment and repeat the process, providing a continuous, relatively
low-cost flow-through mortgage finance system that greatly aids the real estate
industry.
A Serious Structural Problem
The collapse of the mortgage finance
system has left a serious structural problem. The system is now being squeezed
at all its vital points.
The federal mortgage agencies are not
playing the flow-through role they were. Before the crisis they were
aggressive, overleveraged and devoted to expanding home ownership by lending to
weaker credits. But since being taken into federal “conservatorship” in
2008, they have deleveraged, become more cautious and been made to run a tight
ship.
Under conservatorship (which lasts
indefinitely) the agencies have had to rebuild their balance sheets, repay the
government the $187 billion of bailout funds they received, and distribute all
free cash flow to the government, not to investors. In the process, the
agencies have cut back their purchases and securitisation of mortgages from
pre-crisis levels; in 2013 these were 13% less than the year before, and
down a little more in the first half of 2014.
Non-agency credit sources have
disappeared; the agencies now guarantee nine of ten US residential mortgages.
Banks, addressing their own balance
sheet problems, have pulled back on loans to borrowers with lower credit
scores. But the pace of the pull-back has accelerated. In the first half of
2014, total mortgage lending declined by 53% from 2013 levels, according to Inside Mortgage Finance, and non-bank
mortgage lenders among the top 30 originators accounted for 23% of the market,
up from 11% in 2012.
Partly this decline is because the
largest US mortgage lending banks (Wells Fargo, Bank of America, JP Morgan and
Citigroup) are wary of doing business with the federal agencies. The banks have
complained of the massive government lawsuits over technical breaches and
failures that occurred long after the loans were made, but felt they had to
settle rather than face the risk of losing at trial.
Fed chair Janet Yellen said in June
that this concern by the banks has substantially dampened the recovery of the
US housing market. Sales of existing homes in July were 4% below the 5.4
million-unit level of July 2013 and sales to first-time buyers remain
historically low, according the National Association of Realtors. House sales
are still about 25% below what they were in 2006.
Restoring housing activity is a key,
but still missing, component of the broad economic recovery that the government
says it is seeking. A drying up of mortgage credit has continued to be a
drag on the housing market. It may get worse before it gets better.
In August, John Stumpf and Jamie Dimon,
chief executives of Wells Fargo and JP Morgan, respectively, warned (separately)
that unless the government offered a “safe harbour” from such litigation, based
on clearly defined rules for handling the business, they would hold back from
making new loans to the millions of people with lesser credit scores that are
looking for mortgages.
Resuscitate the private sector
The Treasury tried to get out in front
of the housing finance problem in February 2011 when it announced a plan to
wind down the housing finance agencies over time to be replaced by private
capital that would be appropriately disciplined by Dodd-Frank’s enhanced
regulatory umbrella.
The Treasury has done little since then
to support the plan or to explain how it might happen. A bi-partisan effort in
the Senate was made this year to bring a bill to restructure the housing
agencies. This much anticipated bill, which endeavored to get rid of the
federal agencies but preserve the government guarantee of mortgage loans and a
commitment to “affordable housing” ,disappointed just about everyone when it
was revealed in March, and is now permanently stalled in committee.
The best hope for restoring mortgage
finance activity is to rethink ways to get the private, non-government
guaranteed portion of structured finance market restarted. Surely a new set of
more conservative and transparent mortgage backed securities that would appeal
to institutional investors (especially in this low interest rate environment)
can be created, but it will take a combined effort of the banking industry,
credit rating firms and public regulators to make it work. They will have to
cooperate to establish a new set of standards for what goes into the
securities, how they are to be analysed and rated, and how regulatory safe
harbour rules will work to enable the issues to be underwritten.
This is really a job for old-fashioned
investment bankers to take on, one that requires a lengthy series of patient
negotiations with the various parties involved to produce a workable prototype
for a whole new market to develop. Sigmund Warburg and his partners created the
first Eurobond through such a process in 1963.
A similar effort is now essential to
redesign the global structured finance market.
From Financial News,
8 Sept., 2014
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