Has the Mortgage Market Run Out of Steam?
Early last year, the Federal Reserve began purchasing large quantities of mortgage-backed securities (MBS) in a bid to stabilize the housing sector and the secondary market for mortgages. This intervention drove mortgage interest rates down to historic lows, and federal government stimulus measures, such as the tax credit for first-time home buyers, gave new purchasers additional financial resources. The result was a wave of mortgage originations in the middle of 2009, as homeowners refinanced existing mortgages and others bought houses for the first time. However, new origination data from Inside Mortgage Finance shows that origination volumes fell substantially in the first quarter of 2010. This suggests that the mortgage market may slow down now that the refinancing wave has passed and purchaser tax incentives have expired.
Overall originations fell almost 30 percent from the levels of 2009’s first quarter, and there were steep drops in both new mortgage bonds and loans from the top 25 mortgage lenders, most of which are large or regional banks and some of the larger mortgage companies. Even FHA loans—which the federal government has relied upon heavily in its recent housing market strategies—showed declines.
To account for the weakness in new originations, we looked for any obvious dislocations in the financing markets for new or refinanced mortgages. One major consideration is the operation of the government-sponsored enterprises Fannie Mae and Freddie Mac. Since the financial crisis erupted in late 2008, a large number of newly originated mortgages have been converted into bonds (MBSs), which are insured by these GSEs (that is, the federal government, since it has placed both companies into conservatorship.) Since the purchase of loans provides the original lenders with more capital to lend out, the GSEs are effectively financing new mortgage originations. As a result, large upward movements in mortgage bond interest rates can signal investor concerns that might reduce new mortgage originations.
The relative riskiness of mortgage securities—here depicted as the spread of mortgage bond interest rates over 10-year Treasury security rates—did not change much in the first quarter of 2010, and rates on new mortgages are still near historical lows. A decline in mortgage bond issuance, then, does not seem to be the result of bond investors reappraising the riskiness of mortgage holdings, or any obvious hesitancy in the financial markets for mortgage assets.
Without clear hindrances to mortgage origination on the supply side (that is, from credit providers), we can reasonably conclude that originations are falling because demand for new loans and homes is, likewise, declining. Most first-time home buyers must have applied for mortgages ahead of the initial deadline in early November of last year. The deadline was later pushed to the end of April, but the sluggish quarter-over-quarter origination data detailed above suggest that either fewer people used the tax credit after the deadline extension, or many originations were pushed into the month of April (and outside of our available data).
Likely, the decline in new mortgage activity is the result of two upward trends coming to a close. The first originated in last year’s low interest rate environment, which allowed those homeowners who were financially sound to refinance their mortgages at lower rates, beginning many months ago. The second boost to housing—the federal tax credit—has also ended, a development that will weaken first-time buyers’ demand going forward. Absent the force of these stimuli, originations are falling.
There are other factors weighing on the housing and mortgage markets as well. In particular, the performance of existing mortgages is worsening. Foreclosure starts ticked up 0.03 percent in the first quarter of 2010, after having fallen 0.22 percent in the fourth quarter of 2009. More noticeable, though, are loans that are seriously delinquent (90 or more days past due) and therefore on the precipice of foreclosure. These delinquency rates have more than tripled since 2008, and reports indicate that such mortgage performance problems are becoming increasingly broad-based, not limited to subprime loans or particular states. The weakened economy, then, and not regional housing markets or original loan quality, is beginning to account for more and more of the underperforming mortgages.
Increasingly poor performance in existing mortgages may threaten the possibility that new originations will regain the momentum lost in the first quarter. If the so-called “shadow inventory” of near-foreclosure homes puts downward pressure on home prices, it could lower home equity for existing homeowners and undermine their ability to refinance going forward. Falling prices could also make creditors less willing to lend (since homes serve as collateral for new mortgages) and home buyers more likely to wait for reduced prices.