Making the secondary market primary

I’ve been thinking a lot about liquidity lately. Not just because it’s the holidays and, as anyone with a house full of Christian (or agnostic, or atheist) children knows, cash flows out to retailers like floodwaters rushing a city built too close to the Mississippi delta, but also because I’ve been reading a fair amount of mortgage news of late. It seems that plenty of folks I consider very bright are concerned that if the liberal courts and the plaintiff’s bar continue to dance merrily around the foreclosure mess like kids around a Christmas tree, investors are eventually going to just give up on the whole thing, take their money and stomp away. On the surface, it seems like a safe investment. People need homes. They’re not going to let their kids live in a tent, so if you loan them money they’ll pay it back. And since smaller investors (and the GSEs) are now wise to the securitization market and are not likely to fall for some investment bank selling them a tiny slice of extremely high risk for a reportedly high return which later turns out to be worth pretty much what you would expect it to be worth, the lenders will have to come back to your trough for more money to lend in the future. That has all the makings of a stable and profitable business and a good way to employ your excess cash, which we know you have because you’re tired of fighting computers for pennies in the stock market. And it would probably be just that simple if we didn’t have a bunch of legal folks out there who are out to prove that an expensive law degree was actually worth their parents’ money. I mean, the foreclosure mess isn’t dioxin or asbestos, but there’s still plenty of money to be made and since people who aren’t paying their mortgages have that extra cash (or are willing to take out a second mortgage, which HousingWire reported today is more likely to get paid back), there are plenty of lawyers chasing these bucks. But I don’t want to go down that hole again. We’ve written plenty on this and going over it again isn’t going to make it any better. You’re not my therapist, after all (well, one of you may be). Anyway… I want to talk about where the new liquidity is going to come from. I was born in America and that means that I have a built-in faith in the fact that that if money can be made it will be made. It’s what we do here. And there is money to be made in mortgages. So where will the liquidity come from and what hoops will lenders and borrowers have to jump through to get it? Back in the late ’90s, when the industry was just getting into gear, I used to wonder why the GSEs didn’t put their automated underwriting engines out for public consumption and then loan directly. I thought that if Fannie and Freddie ever decided to cut the lenders out of the business, they’d be in a perfect position to do so. I’ve learned a lot about the GSEs since then. It was Wall Street that actually stepped up and did what I thought was obvious, stepping nimbly around the primary mortgage market by becoming part of it, exercising the power of their cash to buy in. According to information I gleaned from exuberant technology providers at the time, they were just about ready to launch Phase II and go directly to borrowers when the bottom fell out of the market. Plenty of champagne went back down to the cellar after that. It turns out that there is so much work that goes into processing a loan that the people who have the money would rather farm the processing out to primary market lenders. Since they don’t have to pay them all that much for most loan products and since some, like the GSEs, have the power to charge additional fees, it’s like cheap labor for them. Of course, cheap labor generally leads to lower quality, which is why we’re now seeing the people who pay the least for mortgages publishing the most pages of loan quality guidelines for their loan sources and making the most buy back requests. That’s not sustainable, in my mind. Eventually, lenders are going to start asking why they’re doing so much work and now carrying so much risk for so little reward. Maybe that’s already happening. I suspect Mortgage 3.0 will involve a new breed of mortgage investor. The people who manage these funds will be more actively involved, which will provide a built-in layer of transparency. I suspect they will promote their own brands, like the GSEs did, provide easy-to-use technology, like some Wall Street conduits did, and generally make it easier and more affordable for lenders to do their jobs. But since they’ll be lending their own money, there won’t be any of the games Wall Street used to play, and since they only make money when their money is put to work, they’ll push lenders to make loans, something the federal government hasn’t been very effective at doing lately. If it comes into focus the way I imagine it will, expect to start seeing some big funds acting like little GSEs over the next two years, but without all the bloat and angst. And expect to see some new language in the borrower’s agreements designed to keep these deals out of court should the investor need to foreclose — which might suggest you will only see these guys working in some states, at least in the beginning. I don’t expect it to be easy to create something new like this in a environment like the one we’re living in today, what with the economic crisis, the legislative morass and all the lawyers out dancing under the full moon, but this is America. I expect it will happen. If you’re already working on something like this, I’d love to hear about it. Rick Grant is veteran journalist covering mortgage technology and the financial industry. Follow him on Twitter: @NYRickGrant