Just a week ago I breathed a sigh of relief hearing the news that government mortgage agencies Fannie Mae and Freddie Mac really appeared to be shrinking. It may have been a case of premature elation. The Wall Street Journal reports that Fannie and Freddie are beginning a new initiative to expand their reach into another aspect of the mortgage market: propping up warehouse lending for smaller banks.
Here's the news, via the Journal:
The two government-backed mortgage companies, the main providers of funding for U.S. home loans, plan to provide advance commitments to purchase home mortgages that meet certain standards. The goal is to reduce risks faced by independent mortgage banks so they can obtain short-term credit.
So what's that mean in English? Let's say you're a little independent bank called Sixth Fourth Bank. You want to write new mortgages, but you don't have the funding to do so. What you used to do pre-crisis was get a warehouse facility.
A warehouse facility is industry jargon for a credit line for writing mortgages. Warehouse lenders provide these credit lines to mortgage originators. A bank uses that credit line to pay for the mortgages it writes. Once the bank has written a mortgage, it sells it to a third party or maybe securitizes it. Then it uses those proceeds to pay back the warehouse lender who it has the credit line with.
So where do Fannie and Freddie come in? Well ever since the bubble popped, warehouse lending came to a screeching halt as part of the credit crunch. Fannie and Freddie seeks to get it moving again by promising to buy those mortgages originated by those independent banks that can't afford to fund mortgages themselves. Since potential warehouse lenders will have a Fannie/Freddie purchase guarantee, they will be a lot more comfortable funding the mortgages.
What's the risk of these agencies taking part in such a program? The loans they intend to buy from the independent banks still must conform to their usual standards. But what happens if the independent lenders don't manage to originate conforming loans? I can definitely imagine a situation where a bank has trouble getting the kinds and/or quantities of loans it wants, if its competition is better at scooping up the most prime borrowers. In such a scenario, does that leave Fannie/Freddie on the hook to pay back the warehouse lender when the independent bank defaults? Presumably, Fannie/Freddie would rather accept the non-conforming loans than pony up the entire credit line utilization to the warehouse lender. Then it would, indeed, be stuck with lower quality loans than it anticipated due to the promise it made to purchase them.
In theory, such imagined negative outcomes shouldn't happen, and it should all run smoothly for Fannie and Freddie. Of course, those were their famous last words prior to the financial crisis when the government had to bail them out. At this point, I'm highly skeptical of anything these agencies do other than shrink.
There must be a reason why warehouse lenders are scared to lend to these banks. If they had the faith that these banks could originate conforming loans to sell to Fannie and Freddie, then they wouldn't need any kind of guarantee. If a program like this was truly safe, I'm not sure why it would be necessary.