Nonbank financial firms spent years lobbying against tougher regulation and stricter capital requirements, arguing that their emerging dominance in mortgage lending didn't pose a risk to the financial system.
Now, many of those companies say they are in desperate need of a bailout to stave off bankruptcy and a potential collapse of the U.S. housing market.
Any rescue might not come quickly, as regulators are holding off on providing additional help to see if policies already put in place ease the industry's expected cash crunch, according to people familiar with the matter. That could lead to anxious moments for Quicken Loans, Freedom Mortgage, Mr Cooper Group Inc. and other nonbank mortgage firms.
Federal mortgage watchdogs didn't predict a pandemic like coronavirus grinding the economy to halt, but many of them did see a potential nonbank liquidity crisis coming. Their efforts to impose more safeguards ran aground against mortgage-industry resistance and bureaucratic reticence to slow the fastest growing source of U.S. home loans, according to industry experts and former government officials.
When government-owned Ginnie Mae tried to require stress tests and higher capital and liquidity requirements, some "nonbanks were violently opposed to the idea," said former Ginnie president Michael Bright. One small lender told Bright that if an event similar to the proposed stress scenario were to take place, he'd just hand Ginnie the keys to his firm.
Shaky foundations
The rise for nonbanks in the mortgage sector and now their pain shows the shaky ground on which much of the post-crisis financial world has been built. Shadow lending has soared, with firms outside the oversight of the Federal Reserve and other regulators helping to fuel a decadelong credit boom. These companies lack access to many of the government subsidies and funding sources that make banks more stable.
While the 2008 housing crash was caused by risky mortgages and fraud, the 2020 crisis isn't the result of bad decisions by lenders. Loads of workers have lost jobs as a result of coronavirus, putting their ability to make loan payments at risk. That point hit home Thursday when the Labor Department reported that a record 6.6 million Americans applied for unemployment benefits last week.
As part of the $2 trillion stimulus bill passed in March, Congress mandated that mortgage servicers allow borrowers to delay payments on government-backed loans for as long as a year. Moody's Analytics Chief Economist Mark Zandi estimates that roughly 15 million households — about 30% of Americans with home loans — could miss payments if the economy remains dormant through the summer or longer.
Under agreements with Ginnie, Fannie Mae and Freddie Mac, servicers themselves must advance the money when borrowers postpone payments and it can take months before they are reimbursed. Congress didn't provide explicit funding to help servicers with that problem, and some of the companies say they don't have the liquidity to handle it themselves.
Unfair blame
Mortgage Bankers Association Senior Vice President Pete Mills said it's unfair to punish nonbanks for being unprepared for a calamity like the coronavirus because it couldn't have been predicted.
"I don't think there is a liquidity standard that could have dealt with this kind of ramp up" in expected delayed payments, said Mills, whose Washington-based group lobbies for the industry.
Should servicers start to go under, federal agencies will have to rush to find other companies to take over the loans. Borrowers could have more difficulty working with their mortgage companies on loan modifications to alleviate some of the pain of the pandemic. Others will have fewer places to go to find new loans.
If not solved, the epicenter of the nonbank crisis will be with Ginnie, which is part of the U.S. Department of Housing and Urban Development. The company guarantees $2.1 trillion in mortgage bonds containing loans to low-wealth borrowers, veterans and others.
While nonbanks service about two-thirds of all mortgages, they handle nearly nine out of ten mortgages backed by Ginnie, according to the Urban Institute Housing Finance Policy Center.
Banks retreat
After the financial crisis, large banks like JPMorgan Chase and Bank of America severely reduced the number of loans they were willing to make under Ginnie-supported programs. Mortgage lending was less profitable than other business lines, and some banks stayed clear because they were scarred by government penalties for alleged fraud.
As the banks retreated, Quicken Loans, Freedom Mortgage, Mr Cooper and others filled the void. Nonbanks' share of new mortgages has risen to 66% of the market from 40% in 2013, according to the Urban Institute.
Freedom Chief Executive Stan Middleman said most nonbanks could last several months without additional government support but that a liquidity facility would still be needed as a safety net if the crisis drags on beyond half a year. He said housing is too important to the economy for Washington to not intervene, adding that the severity of pain that the coronavirus has unleashed is unprecedented.
"This is not like a flood in Missouri," Middleman said. "This is everywhere all at once."
Repeated warnings
Over the past few years, academics and government regulators have sounded alarms that nonbanks don't have the capital or liquidity to withstand an economic downturn. A 2018 paper by researchers at the Fed and the University of California, Berkeley warned that the nonbank mortgage sector "appears to have minimal resources to bring to bear in a stress scenario."
The MBA, the industry trade group, released its own white paper in 2019 calling the researchers' warnings "overstated."
In December, the Financial Stability Oversight Council said nonbanks were a potential source of danger, a warning met with derision by some nonbank mortgage firms.
"When it comes to loan servicers, the FSOC and regulators have spent years fretting about supposed hazards that do not really exist," Freedom's Middleman wrote in a January post on the MBA website. He said FSOC's contention that nonbank servicers were a systemic risk was "bizarre," though he did write that the government could help nonbanks find more stable sources of liquidity.
Regulatory inaction
But while regulators seemed well aware of the potential issues, little was done to fix them.
In 2017 and 2018, Ginnie required some of its largest lenders to present liquidity plans showing what lines of credit and capital they could draw on in a crisis. While some nonbanks appeared strong, others had credit lines that could be pulled by their lenders at any time for any reason, said Bright, making them poor funding sources during a downturn.
Ginnie also asked lenders to subject themselves to stress tests, using a hypothetical economic calamity much less severe than the one being experienced today.
With the bulk of its servicers facing a cash crunch, Ginnie late last month said it would activate a disaster-relief program that lets servicers apply to have Ginnie advance payments to bondholders itself. But that program won't cover other parts of a mortgage payment, such as taxes, insurance and homeowners association payments.
Rescue inevitable?
Now, nonbank mortgage firms say that many of them will go under if they don't get a new lending facility from the Treasury Department and the Fed.
Former Ginnie president Ted Tozer, who was appointed by President Barack Obama, said coronavirus shows that nonbanks need a lender of last resort in the same way that banks are able to draw on the Fed in times of peril.
"We need to find a solution so we're not going through this every time we have some sort of crisis," Tozer said.
