Many educators and investors in the real estate-backed note industry are talking about NACA and their $0 down, $0 closing costs, $0 fee, no income limit and no need for perfect credit loans and rightfully so, but there is a much deeper issue here and it will not end pretty.

That deeper issue is mortgage liquidity. Unfortunately, this issue is somehow being completely ignored, yet it will be the beginning of the next mortgage crisis.

Let’s start with some facts:

· Nonbanks originated about half of all mortgages in 2016, and more than banks in 2017 and 2018

· 75% or more of mortgages today are insured by the FHA or VA

· Both shares are much higher than those observed at any point in the 2000s.

· Nonbank mortgage companies are vulnerable to liquidity pressures in both their loan origination and servicing activities

The extremely high share of nonbank lenders in FHA and VA lending suggests that nonbank failures could be quite costly to the government. Why? Because FHA and VA loan payments are further guaranteed by a wholly-owned government corporation within HUD called the Government National Mortgage Association (Ginnie Mae). So, what happens if a borrower goes into default? See the chart below.

When it comes to loan-risk, on the surface, a Ginnie Mae backed loans look less risky than Fannie Mae and Freddie Mac (GSE’s) backed loans. After all, the “capital of the issuer” of the loan is on the hook after the homeowner and FHA/VA.

That’s exactly where the weak link is. The “issuer” or nonbank lender, doesn’t have any real capital in the deal. Nonbanks fund their deals using warehouse lines of credit from FDIC insured banks. They have 6% cash on hand. If the loan goes bad they don’t have any cash so the default falls on Ginnie Mae (the government, thus us the taxpayers).

This is a lengthy and complicated topic. I have tried to condense it here but will have more detail on my podcast.

Kevin Shortle

Ref: Brookings Papers on Economic Activity