As the COVID-19 pandemic began rippling through the global economy in March, it created an instantaneous mortgage liquidity crisis. The Federal Reserve quickly stepped in to support market liquidity for federally-guaranteed mortgages by directly purchasing mortgage-backed securities (MBS) issued by Fannie Mae, Freddie Mac, and Ginnie Mae (collectively, Agency MBS). In addition, the Fed reinstated the Term Asset-Backed Securities Loan Facility (TALF), supporting numerous other asset classes beyond Agency MBS. Unfortunately, the Fed continues to omit all private sector residential mortgages (non-federally guaranteed) from its liquidity support programs. This glaring omission has created a large divide within the housing sector, and if left unremedied, will have far-reaching consequences for housing, homeowners and taxpayers for years to come.
The private mortgage market serves creditworthy borrowers who do not qualify for the often inflexible government mortgage programs. These borrowers include families living in higher-cost areas of the U.S., gig-economy workers, borrowers from low- and moderate-income communities without a traditional income (i.e., reported on a W-2), and those who cannot afford a standard down payment. Americans falling within these groups have proven to be strong borrowers and deserving homeowners. They simply require mortgages that do not fit neatly inside the parameters of government mortgage underwriting rules.
Like most other industries, the private mortgage market and the institutions and investors that support it remain under distress. Lenders rely on secondary market liquidity and investors to fund the mortgage loans they extend to consumers. Just like in the Treasury and Agency MBS markets, liquidity in the private mortgage market dried up overnight as the COVID-19 crisis grew. However, because the former has benefitted from federal support while the latter has not, the results could not be more stark. Four months into this crisis, private mortgage rates remain significantly higher than those supported by the Fed, and in many cases, the liquidity disparity has made mortgages unaffordable for otherwise qualified borrowers.
Ironically, shutting down the private mortgage market is the exact opposite of what the current and past administrations have said they want. The appeal of the private mortgage market is that credit risk is fully borne by private capital and not the government. For over 10 years since the Great Recession, U.S. policymakers and lenders worked hard to bring back the private mortgage market to avoid our entire housing finance industry standing on taxpayers’ shoulders. Major advancements were made, particularly with respect to underwriting quality and federally-mandated borrower protections.
These reforms, coupled with strong underwriting discipline among both originators and investors, created a growing asset class of high-quality and AAA-rated private-label mortgage-backed securities (PLS). These investments are institutional quality and reside on the balance sheets of banks, pension funds, and insurance companies. Before COVID-19, the sector was poised to take another leap forward as a new wave of institutional investors began to commit significant resources. But now all those efforts to rebuild the private mortgage market could be for naught.
Suffice to say, it is gut-check time for the Federal Reserve and other government policymakers. Supporting liquidity for AAA-rated PLS through TALF is a simple and safe way to ensure that affordable mortgages remain accessible to all consumers. Additionally, if the private mortgage market continues to be on the outside looking in, it is hard to see any successful path for reducing the government’s footprint in the mortgage market when this crisis is over. And that’s a shame, because the federal government will then be pressed to expand into the entire mortgage market, or risk denying many Americans an equal opportunity at homeownership.
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