With all of the foreclosures and bankruptcies that are being triggered by the subprime mortgage crisis why don’t lenders just put all of these homeowners in better loans? We are asked this question on our mortgage blog quite often. It’s a reasonable question too. If it’s the bad loans that are causing the problems wouldn’t be cheaper for the lenders to just bite the bullet and fix the bad mortgages? Meaning, wouldn’t it cost banks less money to lower interest rates and fix adjustable rate mortgages on their loans than the billions they are losing from all of the foreclosures?
In some cases banks are doing just this because it does make sense. However as I will explain, this is much easier said than done for most banks. The reason is that very few banks these days “own” the mortgages they service. A few regional and national banking chains do maintain a portfolio of loans that they originated, but by in large most banks do not. Most mortgages are owned by a pool of investors and are merely serviced by the company that homeowners send their payments to.
This is why when you call your current lender that you already have to refinance they make you re-qualify for a new mortgage again. While I was originating mortgages, I had countless borrowers call me to refinance that were disgusted with their mortgage company for that very reason. It seems to reason if you have paid your mortgage on time for ten years the bank would just lower your rate to keep from jumping-ship to another lender. The problem is that they have to put your new loan in a new portfolio and sell that portfolio to other investors, this is called securitizing.
Banks and lenders buy money to sell much as retailers do for the inventory that they keep on their shelves. For instance, a toy store can purchase a crate full of toy soldiers at a wholesale price then put them on the shelves and retail them for a profit. Banks buy and sell money the same way from their retail, or mortgage divisions. The only difference is that banks reach their loan capacity they have to take these groups of loans and sell them to investors on Wall Street. If banks didn’t do this they would loan all of their money and be out of the mortgage business.
Now you have a group of loans that is being serviced by the bank that is owned by 1 to 100 different investors. That group of loans is treated like the wholesale the box of toy soldiers that is sold by the case not individually. To ask the investors to reach into the “box” and pull one soldier out and alter it would disrupt the total value of the box as a single unit. This would also upset the other investors who have money tied up in the box of toys.
Staying with the toy soldier analogy, what has happened to banks in this crisis is they can’t sell the box of toys to the investors anymore. The retailer has $100 invested in the box of toys and investors believe that the toy soldiers are a bad investment and will only offer $70 dollars for the box. This means that the retailer has to hold onto the box until prices rise back to $100 or sell the box for the $70 dollars and take the loss. This is the same with banks today; either they cannot afford to sell their loans or they have chosen not to and ride out the storm.
Both way lenders and banks have stopped buying and selling money as freely as they used to and cash is in short supply. When supply is short and demand is high prices typically go up. This is why the Federal Reserve Chairman keeps lowering the prime rate in an attempt counter higher rates that would almost drive a nail in the coffin of retail lending. As of this article Atlanta mortgage rates are around 5.75% for a thirty year fixed mortgage and would probably be in the mid-sevens without Bernanke’s involvement.
Passing legislation that over regulates banks and lenders will not solve our problems. Neither will instituting individual government plans aimed at helping a finite amount of borrowers like some in congress have suggested. The answer to this subprime mortgage crisis will be derived from a plan to restore confidence in mortgage backed securities that will allow the flow of money to open up once again. The free market will correct its mistakes and lending will begin a new day.