It is a pleasure to join you here today and to share a few of my thoughts on financial stability issues with you. I would like to thank the Cleveland Fed and the
It seems especially relevant to look closely at financial stability at this time, as the COVID-19 pandemic has had a profound impact on the
Fortunately, both our economy and our financial system were very strong when the pandemic hit. Most banks began 2020 with higher capital ratios and more liquid assets than they had in previous downturns, which helped them remain a source of strength in March and April. As the crisis intensified in March, serious cracks emerged in several areas of financial intermediation crucial to the health of the economy, including
To address strains in mortgage finance, the
These vulnerabilities were not entirely a surprise to me. When I served as a banker and, subsequently, as the state bank commissioner in
I will begin today by describing the evolving role of mortgage companies in mortgage markets and the risks to financial stability that activity entails. I will then focus on developments in mortgage markets during the COVID-19 pandemic and discuss how actions by the
The Role of Nonbank Financial Institutions in Mortgage Markets
In the 1980s and 1990s, the share of mortgages originated by mortgage companies increased considerably, as expanded securitization of mortgages allowed mortgage companies, which lack the balance sheet capacity of banks, to compete with banks in the mortgage market. The role of mortgage companies increased further in the 2000s with the growth of the private-label mortgage market, where MBS sponsors are private firms without government support. But the last financial crisis and the prolonged housing slump that followed led to a sharp contraction in mortgage company activity. In 2006, mortgage companies accounted for around 30 percent of originations; by 2008, at the bottom of the housing crisis, this share had fallen to around 20 percent.
In the past few years, the market share of mortgage companies has risen sharply, well surpassing their share before the housing crisis. Today these firms originate about half of all mortgages, including more than 70 percent of those securitized through
The expanding presence of mortgage companies has brought benefits to consumers and the economy. Among the benefits are increased competition and technological innovation. Mortgage companies are generally able to react more nimbly to changes in market conditions and have been faster to deploy new technologies such as online mortgage origination platforms. But the rising market share of mortgage companies has also brought with it increased risks. I will focus here on the risks most relevant to financial stability.
One major vulnerability of mortgage companies is liquidity–that is, their ability to finance their portfolios of assets./3 Unlike banks, mortgage companies typically do not have access to liquidity from the Federal Home Loan Banks or the
The risk of events like this one repeating is probably more limited today because mortgage companies primarily originate mortgages that are securitized through the far more stable GSE or
If these firms collapse, what are the repercussions? Clearly, there is considerable potential for harm to consumers, and that harm would likely be concentrated in communities that are traditionally underserved. In recent years, mortgage companies originated the majority of the mortgages obtained by Black and Hispanic borrowers as well as the majority of mortgages to borrowers living in low- or moderate-income areas.
What does this have to do with financial stability? One aspect of financial stability is the amplification of shocks–in other words, how a problem initially confined to one part of the financial system can spread to involve broader swaths of borrowers and investors. During the housing crisis, the fragility of mortgage companies was an important source of this kind of amplification. In particular, rising mortgage defaults led to the collapse of many mortgage companies, which in turn was one of the key drivers of a significant pullback in the supply of mortgage credit. That tightening in credit then weighed on house prices, as potential homebuyers, who once would have been able to get a loan, found mortgages expensive or impossible to obtain. As a result, even families who had not been involved in the mortgage frenzy of the mid-2000s found the prices of their homes falling sharply. Today's housing market is much more robust, and the risk of a financial crisis originating from this sector is currently low. Nonetheless, if some large mortgage companies fail and other firms do not step in to take their place, we could see adverse effects on credit availability.
Policy Responses to the COVID-19 Crisis
Against this backdrop, the massive economic shock triggered by the COVID-19 pandemic broadly tested the resilience of our financial system. As the pandemic unfolded, strains occurred across financial markets as investors dashed for cash amid widespread lockdowns and fears about the economic and financial outlook. Mortgage markets, in particular, began to show significant signs of stress. The MBS market, like those for other fixed-income securities, became extremely volatile, and with the unemployment rate spiking, market participants worried that borrowers would be unable to make their mortgage payments.
On the fiscal policy front, the CARES Act (Coronavirus Aid, Relief, and Economic Security Act) provided economic stimulus checks and enhanced unemployment benefits to individuals as well as eviction moratoriums for renters and a requirement that mortgage servicers grant borrowers up to 12 months of forbearance. All of these policy responses were crucial in easing the stresses in financial markets and helping us weather the period when much of the economy was shuttered.
An unfortunate consequence of the mortgage forbearance measure was the pressure it put on the funding needs of servicers, particularly mortgage companies, which are required to continue advancing payments on loans in forbearance. In April,
Looking Back and Taking Stock
Although we continue to closely monitor the path of the virus and the public response to it, economic and financial conditions have improved much more than many had expected in the spring. It is a great relief that the most dire scenarios that seemed possible in the spring have not come to pass, which is largely due to supportive fiscal and monetary policy. In addition, the near-term stresses in financial markets have abated, providing support for the very strong recovery to date. The
To date, mortgage delinquencies and the take-up on forbearance appear to be limited and well below early fears of significant problems. The increase in employment since April, income support from stimulus payments, programs such as the Paycheck Protection Program that helped small businesses retain workers, and enhanced unemployment insurance all helped borrowers continue making their mortgage payments. And forbearance provisions in the CARES Act to homeowners with mortgages securitized by the GSEs or
The share of mortgages in forbearance rose above 8 percent last spring, but it has since fallen to below 6 percent. And of those loans in forbearance, about one in six are current in their payments, reflecting the broader economic recovery./6 This improvement has not been uniform, though, and the decline in the forbearance rate for loans in
Some Lessons Learned
Even as we take some comfort in these positive developments, we are also giving due consideration to the financial market vulnerabilities that were made evident in this crisis, and we are examining ways to address them. One prominent vulnerability, which I have described here today, relates to the funding and liquidity profile of mortgage companies. In different circumstances, the large-scale delinquencies and defaults we saw last spring could have caused some mortgage companies to fail, especially if the surge in origination and refinancing income had not materialized. Because many mortgage companies both originate and service mortgages, strains in these firms' servicing books could also weigh on their origination activities. As I noted a moment ago, any reduction in credit availability would be most acute for borrowers from traditionally underserved communities, where mortgage companies have a particularly high market share.
Even before the pandemic, regulators had widely recognized that the oversight and regulatory infrastructure for mortgage companies is much less well developed than for banks, and it could benefit from an update. To that end,
An encouraging feature of all of these proposals is that they recognize the complexity of the mortgage company regulatory structure. The states are the primary regulators, but most large mortgage companies operate in multiple states and are also subject to counterparty requirements from the GSEs and
The harder task, however, is thinking about what the overarching regulatory framework should be for mortgage companies. The risks that mortgage companies face are different from those that banks face. Mortgage companies will be more affected by shocks to the mortgage market than banks, which have much more diversified portfolios. As I have mentioned, mortgage companies have less access to liquidity than banks; at the same time, they do not pose the risk of a claim on the deposit insurance fund. These factors suggest that the optimal regulatory framework for mortgage companies should differ from that of banks.
These are difficult questions, and a casual observer might wonder if it is really necessary to grapple with them, especially as the industry appears to have successfully weathered the strains of the past few months. But I would argue that this “success” was reliant on rising home prices, low defaults, and massive fiscal and monetary stimulus. But we certainly can't count on all of these factors being present in future periods of economic stress.
Around the world, regulators are deliberating about how to address a variety of nonbank entities that can pose systemic risks. In work published last week, the FSB highlighted the need for a macroprudential approach to nonbank financial intermediation./9 Members of the FSB are not calling for bank-like regulation for nonbanks, but they recommend a framework of supervision and regulation that takes into account systemic risks that can be posed by nonbanks.
I would also note one lesson we learned in March, which is that conditions in financial markets can deteriorate very rapidly and unexpectedly. I'm paying close attention to the issues highlighted in my remarks today, and keeping an open mind. But I think it's clear, that doing the hard thinking and planning now–at a time when conditions afford us the time do so–is a very worthwhile investment. Our financial system and our mortgage market will be more resilient when they welcome and appropriately manage the risks associated with both bank and nonbank mortgage firms.
1. See You
2. The data are
6. The data are from
9. See Financial Stability Board (2020), Holistic Review of the March Market Turmoil (