The Jumbo Mortgage Window Slams Shut

Are we in the middle of a fully-blown credit crunch, or is this merely an unpleasant and discontinuous repricing? The answer to that question lies in whether credit is available at any price. Have funding windows slammed shut, or are lenders merely requiring higher interest rates than borrowers are willing to pay?

My feeling is that it's a little bit of both, but that there are definite signs of a real credit crunch, especially in the mortgage market.

The WSJ's James Hagerty has an excellent front-page article today which concentrates on so-called jumbo mortgages – loans of more than $417,000, which won't be guaranteed by Fannie Mae and Freddie Mac. Spreads are widening so much in this market that jumbo-mortgage rates are rising alarmingly despite long-term interest rates coming down. A prime 30-year fixed-rate jumbo loan now costs 7.34%, up more than 80bp since mid-May.

The problem is not defaults, which have remained low on prime mortgages in general and certainly on anything fixed-rate. The problem is the bond market, according to Doug Duncan, chief economist of the Mortgage Bankers Association:

Alarmed by weakness in the housing market and rising foreclosures, investors who buy loans and securities backed by mortgages have fled the market for almost any loan that isn't guaranteed by Fannie Mae or Freddie Mac, Mr. Duncan and others said. That means lenders must either hold loans, at least temporarily, and face the risk of falling values for them, or seek out borrowers who qualify for loans that can be purchased by Fannie and Freddie.
For other types of loans, Mr. Duncan said, "there is no market." He said it isn't clear how long the market will remain disrupted, but said some mortgage bankers fear the current paralysis could last weeks. "We're getting calls from members [of the lenders' association] who are quite desperate about their circumstances," Mr. Duncan said. Large banks have the capacity to retain loans on their books, but many other lenders can only make loans that can be sold quickly.

For mortgage lenders without a large balance sheet of their own, this is very bad news: they're simply not set up to warehouse loans. Look at the way American Home Mortgage imploded: the company was done in by its banks, which abruptly pulled their credit lines – and credit, of course, is the lifeblood, the oxygen, of any mortgage company. Without it, you last a few minutes at most. That's one reason why Countrywide is a risky bet, even at book value: it has lots of credit today, but no one is sure whether that credit will stick around tomorrow.

Jumbo mortgages are now being priced at levels above any reasonable expectation of credit risk: they're expensive entirely because of market risk. So I'm very sympathetic to mortgage broker Darren Weisberg, who's quoted in the WSJ article as saying that "nobody in their right mind would pull the trigger" on one of these things today.

This, then, looks like a credit crunch more than it looks like a repricing. A similar syndrome might well play out in the LBO market, too, as banks find themselves warehousing the loans they underwrote, rather than being able to wrap them up in a pretty CLO and sell them in the secondary market.

I'm still reasonably hopeful, however, and not because I think the Fed will or should cut rates today or any time soon. Rather, I'm placing my faith in other sources of liquidity: foreign central banks, sovereign wealth funds, hedge funds looking for distressed assets, even retail investors who are still finding it difficult to get a nice return on their fixed-income investments. If I was a retail bond investor, I'd love to buy fixed-rate jumbo loans at these prices. And where there's demand, supply will surely follow.