In recent years a growing number of mortgage professionals, investors, and observers have said the industry is more vulnerable than ever to disruptions in the bond market and more likely than ever to experience them.
A report by a Mortgage Bankers Association-affiliated think tank that repeatedly calls such a "shock" all but inevitable in the next few years is a clear sign that this view has grown pervasive.
"Firms need to plan for the possibility," the report warns.
The prediction is one of several dozen in the 182-page report to be released today by the Council to Shape Change, a group of 19 executives from a cross section of companies involved in residential and commercial mortgage finance.
Though the council was established last fall by the MBA, conceived by the trade group's chairwoman, Regina Lowry, and supported by its staff, the analysis is independent.
In an interview, Ms. Lowry called the report "quite a provocative document" that met her goal of being an opened-eyed assessment.
In some cases, the report goes further than, or runs counter to, the MBA's policy positions. For instance, the report says that "reasonable limits" on the portfolios of Fannie Mae and Freddie Mac would have no real effect on liquidity, and that the long-shot possibility that the mortgage interest tax deduction could be eliminated may in fact benefit the industry by creating more economic growth. (See story [third item]
The importance of private mortgage securitizations should continue to grow as fixed-income investors increasingly see the debt (and offshoots) as interchangeable with other types, the report said. Because of this, "bond guys" will play an increasing role in shaping the business, and rating agencies will further become quasi-regulators.
However, the report says heavy reliance on financial markets - and hence on unpredictable foreign investors, hedge funds, and exotic instruments such as credit default swaps and collateralized debt obligations - has increased the industry's vulnerability and will continue to do so.
Sudden shifts in investment demand or a full-blown systemic event could reverberate through the real estate industry at a time with reasons to brace for both possibilities, the report said.
Investment demand shifts could occur because of looming government entitlement spending and other reasons for deficits that may crowd out other debt. Some say they also could occur because many ultimate holders of credit risks are too optimistic and may pull back when proven wrong, creating an amplified effect because of collateralized debt obligation retranching.
According to the report, many also believe a systemic event could stem from a growing amount of counterparty risk in the form of credit derivatives - which provide a "channel" for a crisis to spread - and a lack of transparency in the space.
Nevertheless, the report is optimistic that the U.S. economy's apparent resilience, and the Federal Reserve Board's steadying hand, will keep the impact manageable, even if the Fed itself may "light the match" by tightening too much.
Andy Woodward, the council's chairman and a retired Bank of America Corp. mortgage chief, said in an interview that talk about a meltdown awaiting the industry was a "recurring theme" of the group's discussions and the report, in part "simply because we've been through the best of times."
Considering the untested areas that real estate finance is relying on, "it's only prudent to expect a disruption in the marketplace, not unlike" the 1998 implosion of Long-Term Capital Management, he said.
The mortgage bond pioneer Lewis Ranieri told American Banker in June that he worries about how mortgage risk is repackaged today, saying "it's not clear that we haven't gone, in some ways, too far." The council's report also suggests that the growing access to synthetic bets on mortgage risk may hurt demand for actual debt.
Portfolio lenders, particularly large ones, and small originators with close ties to them would be best able to weather the shock, the report says. Those with room on their balance sheets could even take of advantage of the buyer's market a shock would create.
The shock should accelerate industry consolidation, and even without one, the ranks of midsize originators should continue to thin, making the industry look even more like a "barbell," the report says.
Some parents of large home lenders will abandon them, and some small lenders will fold, sometimes with messy consequences, the group said.
