How one month nearly broke the housing ecosystem

Housing in the time of the coronavirus

One month.

Just 31 days. That’s all it took to change everything.

March 2020 will long be remembered as the month that the coronavirus nearly broke the U.S. housing finance system.

It’s pretty crazy how much things can change in just a few weeks.

The original thinking about 2020 was that this year was going to be a down one for the mortgage business. The expectation was that interest rates would rise throughout 2020, rebounding from the unexpected fall that buoyed the mortgage business throughout the latter half of 2019.

Last year’s decline in interest rates led to a surge in refinances, but it wasn’t expected to last.

The original projection from the Mortgage Bankers Association, for example, said that refinance activity was expected to fall dramatically in 2020, retreating by nearly 25% from 2019. Overall lending was also expected to fall.

But that wasn’t the case for all segments of mortgage lending. In fact, lending to borrowers outside the Qualified Mortgage box was expected to continue growing throughout 2020 as investors’ appetites for riskier loans and the yields that came with them was increasing.

But the coronavirus changed everything.

In just over a month, the virus spread from China to the rest of the world.

In that short window of time, the virus upended the mortgage business, U.S. financial markets and the world’s economy in ways that haven’t been seen in at least 10 years, and maybe ever.

And by the time COVID-19, the disease caused by coronavirus, was rampaging across the U.S., any expectations for what would happen in 2020 were completely thrown out the window.

In a single month, the mortgage business saw mortgage rates hit an all-time low, an unprecedented and short-lived spike in refis, an economic meltdown and record unemployment, the Federal Reserve breaking out its financial crisis playbook to try to stem the tide, the government taking extraordinary steps to try to keep the economy (and the mortgage business) from completely exploding, and numerous lenders either shutting down their lending for a time or shutting down entirely.

And all that happened in March. 


By the time the dust began to clear, mortgage lending, servicing and the secondary market in the U.S. had all substantially changed. And beyond that, an entire lending segment was seemingly wiped from the map overnight.

To put it frankly, all hell broke loose. And it didn’t ever seem to stop breaking.

Things really began changing quickly in early February, when it appeared that the virus’ spread was escalating in China.

At that time, investors were already beginning to get nervous about the impact of the virus on the world’s economy. Given that China’s economy accounts for more than 15% of the world’s gross domestic product, the concern was understandable.

Investors, for the most part, seek stability. They want a nice, steady rate of return on their investments. That goes for mortgage bond investors, government bond investors, and pretty much every other investor there is.

But the uncertainty surrounding China’s economy was making investors uneasy.

And what typically happens in times of global economic turmoil is that investors seek out U.S. bonds, which tend to be thought of as much safer than other financial instruments.

That leads to increased competition for those bonds, which drives down yields. And that increased competition for bonds, including mortgage-backed securities, means that investors have to accept lower returns, which leads to lower mortgage rates.

And that’s exactly what happened this time, too. Investors stampeded towards U.S. Treasury bonds, sending the yield on the benchmark 10-year Treasury note to lows never seen before.

The 10-year Treasury tends to act as a loose benchmark for mortgage rates, and its decline to record lows led observers to suggest that interest rates could soon hit all-time lows as well.

That’s what happened in early March, when rates fell to 3.29%. The previous all-time low was 3.31% in November 2012.

Rates falling that low led to an unprecedented spike in refis. Unprecedented really is the right word. In fact, numerous lenders told HousingWire at the time that they’d never seen a lending environment like the one that happened in early March.

In fact, as rates fell to an all-time low, mortgage applications skyrocketed, jumping 55% in just one week. Much of the surge came from refinances, as demand for refis rose to an almost 11-year high.

That explosion of mortgage activity, which took place in just a few days, led the MBA to double its refi forecast for 2020, projecting that there will be $1.232 trillion in refis this year. That’s twice as many as the group originally expected.

Overall, the MBA said it expects there to be $2.609 trillion in total mortgage originations in 2020, which would be a 20.1% increase from last year. And it’s not as though 2019 was any slouch, by the way. Thanks to the unexpectedly low interest rates of the second half of the year, 2019 saw a 12-year high in mortgage originations.

But that surge in activity didn’t come without consequences.

Lenders across the country, including the biggest ones, were breaking records daily for application and lock volume. But many lenders were unprepared to deal with volume at that level. That led to the record lows in interest rates being a short-lived phenomenon. Lenders’ inability to deal with the demand coupled with bond investors’ unease with the volume of prepayments led to a rise in mortgage rates.

As the mini refi boom was happening HousingWire spoke with numerous lenders, mortgage brokers and other mortgage professionals, and several said that some lenders were keeping their rates higher than they could be because they were not fully equipped to deal with the surge of demand.

The term that several used for this phenomenon is “throttling,” with lenders keeping rates above where they could be to ensure they can fulfill all the business they are getting.

The issue was capacity. Put simply, there is only so much volume that mortgage companies can handle. Some can handle more than others, depending on their size and technological capabilities. But others were already being stretched thin by the surging demand.

Beyond that, mortgage bond investors began growing wary of an impending prepayment explosion that would wipe out many of their investments.

When investors buy a mortgage bond, they expect that bond to pay out over time. Typically, it’s over 30 years, the term of the loans themselves. But with prepayments (borrowers paying off their mortgages early via refinancing, selling their house, or other means), investors take a loss as the prepayment amount is less than the investor would have received over the life of the loan.

Combine the issues on the front end and the issues on the back end, and the market saw the gap between the 10-year Treasury and mortgage rates expanding further, with rates moving higher and bond prices moving lower. 

That stemmed the refi surge to a certain degree, but then everything changed again as the spread of the virus accelerated. 

Seemingly overnight, much of the country went into a virtual shutdown, and mortgage lending whiplashed from one extreme to another.

Where just a week earlier the industry was being crushed by demand, the impact of the virus quickly crippled the economy, leading to record spikes in unemployment as large segments of the country shut down. 

That led the mortgage business to shift from talking about what a great year it was going to be, to “How do we keep the housing ecosystem from absolutely imploding for the second time in the last 12 years.”


The words “widespread forbearance” and “payment deferrals” started being thrown around in earnest for the first time since the housing crisis. 

But this was different than the housing crisis, which unfolded over the course of many months. 

This time, the mortgage industry went from thinking about how to deal with all the refis to how to keep people in their homes and keep the housing finance system from falling apart seemingly over the course of two weeks.

Meanwhile the federal government, state governments, the GSEs and many banks moved quickly to help borrowers by suspending foreclosures and evictions, offering months of forbearance and taking other steps to aid borrowers and renters.

But the issue of widespread, potentially long-term forbearance led to an immediate crisis at mortgage servicers, especially the nonbank servicers.

When a borrower fails to make their monthly mortgage payment, the mortgage servicer is still required to pay the principal and interest to investors, as well as pay the real estate taxes, homeowners’ insurance, and mortgage insurance on their behalf.

Servicers typically retain some reserves to cover such shortages, but they don’t have enough money to cover the mortgage payments if a widespread forbearance program is put in place.

Here’s how the mortgage industry, incuding the Mortgage Bankers Association the American Bankers Association and many other groups, laid out that problem in a letter sent to federal decision-makers: “To give one a sense of scale, if 25% of the nation receives forbearance for only three months, servicers will have to cover payments of roughly $36 billion. If they received it for nine months, then the cost would exceed $100 billion.”

In their letter, the groups said that it was “critical” for the government to “create a vehicle to provide lenders and servicers with access to the liquidity” they would need to fund such a program.

“Non-bank mortgage lenders could experience meaningful strains on their liquidity given the consumer mortgage forbearance programs being proposed by the U.S. government in response to the coronavirus pandemic,” Fitch Ratings noted in a report. “The pressure on the non-bank mortgage sector is particularly acute at present, given more limited funding profiles compared to banks, and could be exacerbated further as an unintended consequence of the government’s mortgage forbearance program.”

Luckily, the government, via Ginnie Mae, stepped up in late March to roll out a program that would advance the P&I payments to investors on servicers’ behalf, thereby alleviating the cash crunch that many servicers were facing.

Here’s how Ginnie Mae Principal Executive Vice President Seth Appleton described the program when announcing it in late March:

Ginnie Mae fully anticipates implementing within the next two weeks, via an All Participants Memorandum (APM), a Pass-Through Assistance Program (PTAP) through which issuers with a P&I shortfall may request that Ginnie Mae advance the difference between available funds and the scheduled payment to investors. This PTAP will be effective immediately upon publication of the APM for Single Family program issuers, with corresponding changes made to Ginnie Mae’s MBS Guide in due course. We anticipate publishing PTAP terms for HMBS (reverse mortgage) and Multifamily issuers shortly thereafter.

Under current policy, the advancing of funds by Ginnie Mae to an issuer as a result of a Major Disaster declared by the President of the United States would be a considered an event of default under our program. But, because the current National Emergency is not limited in geographic scope in the way a natural disaster is, a P&I advance by Ginnie Mae through the PTAP will not be considered an event of default, though all other program requirements will continue to apply. In return for any payments advanced under the PTAP, issuers will be required to sign an agreement with Ginnie Mae and must repay the advance within a specified time period. The agreement with Ginnie Mae will provide for extension requests and specify the rate of interest that will apply to the borrowed advances.

To be perfectly clear, borrowing under the PTAP should be a “last resort” financing option to alleviate a liquidity shortage faced by any Ginnie Mae issuers. PTAP’s purpose will be to support the forbearance and loss mitigation programs of our insuring agency partners (FHA, VA and USDA) by minimizing potential disruption in the mortgage servicing market so that those federal mortgage insurance and guarantee programs can be administered efficiently and with maximum help to borrowers. Ginnie Mae will choose to make these advances only where doing so will further the program mission and the American taxpayers who stand behind it.


Servicers weren’t the only ones facing difficulties as the virus crisis worsened.

Lenders and investors were hurting too.

As part of the government’s response to the economic strife, the Federal Reserve began buying mortgage bonds in bulk, a staple of its response to the housing crisis.

The goal was to calm the mortgage market and ensure the continued flow of funds, but the program led to big problems at many companies that deal in the secondary mortgage market.

According to MBS Highway’s Barry Habib, the issue with the Fed buying bonds by the ton is that it sent the secondary market into total turmoil.

Here’s how Habib described the problem:

The Fed’s desire to bring mortgage rates down isn’t just damaging servicing portfolios because of prepayments, it’s also wreaking chaos in lenders’ ability to hedge their risk. Let’s look at what happens when a borrower locks in their mortgage rate with a mortgage lender. Mortgage rates are based on the trading of Mortgage Backed Securities. As Mortgage Backed Securities rise in price, interest rates improve and move lower. A locked rate on a mortgage is nothing more than a lender promising to hold an interest rate, for a period of time, or until the transaction closes. The lender is at risk for any MBS price changes in the marketplace between the time they agreed to grant the lock and the time that the loan closes.

If rates were to rise because MBS prices declined, the lender would be obligated to buy down the borrower’s mortgage rate to the level they were promised. And since the lender doesn’t want to be in a position of gambling, they hedge their locked loans by shorting Mortgage Backed Securities. Therefore, should MBS drop in price, causing rates to rise, the lender’s cost to buy down the borrower’s rate is offset by the lender’s gains of their short positions in MBS.

Now think about what happens when MBS prices rise or improve, causing mortgage rates to decline. On paper, the lender should be able to close the mortgage loan at a better price than promised to the borrower, giving the lender additional profits. However, the lender’s losses on their short position negate any additional profits from the improvement in MBS pricing. This hedging system works well to deliver the borrower what was promised, while removing market risk from the lender.

But in an effort to reduce mortgage rates, the Fed has been purchasing an incredible amount of Mortgage Backed Securities, causing their price to rise dramatically and swiftly. This, in turn, causes the lenders’ hedged short positions of MBS to show huge losses. These losses appear to be offset, on paper, by the potential market gains on the loans that the lender hopes to close in the future. But the broker dealer will not wait on the possibility of future loans closing and demands an immediate margin call. The recent amount that these lenders are paying in margin calls is staggering. They run in the tens of millions of dollars. All this on top of the aforementioned stresses that lenders are having to endure. So, while the Fed believes they are stimulating lending, their actions are resulting in the exact opposite. 

That led to the market for loans that weren’t backed by Fannie Mae and Freddie Mac slowing down to a near stop. Government loans (those backed by the Federal Housing Administration, Department of Veterans Affairs and Department of Agriculture) and jumbo loans both slowed down considerably.


Meanwhile, non-QM loans, which were expected to exponentially grow this year, ground to a halt.

Many, if not all, of non-QM lenders shuttered their lending businesses for a period of weeks. Some shuttered their businesses entirely. 

The reason? With the Fed sucking up much of the available mortgage bonds, investors were much less eager to take on riskier loans, especially the economy collapsing.

Non-QM borrowers have credit characteristics outside of the norm, which could make them more likely to default under severe economic stress. 

Beyond that, a report from S&P Global Ratings noted that the bulk of non-QM originations in the last few years came from areas that were among the most impacted by the virus: specifically, New York and California.

With both of those states engaged in unprecidented, near-total shutdowns, the non-QM lending environment disappeared.But the impact wasn’t limited to the coasts. Everyone felt the impact.

“Even if the damage to the job market proves temporary, lower earnings and layoffs are already straining consumer finances, a dynamic that will worsen unless significantly mitigated by government or servicer actions,” analysts from Moody’s Investors Service wrote in a report. “

“Several types of consumer borrowers are more likely to be experiencing reduced income even without suffering job losses,” Moody’s analysts continued. “They include the self-employed, such as those who own small businesses or are reliant on contract work. They also include employees who are paid by the hour or with tips, such as factory workers or waitstaff at restaurants. Workers with significant shares of their income tied to commissions or bonuses also could be more at risk.”

Put simply, borrowers that are a “sure thing” are the only ones that lenders wanted to lend to as the crisis worsened. Realistically, borrowers who were a “sure thing” were the only ones lenders really could lend to because investor interest and ability had all but dried up.

The bottom line: Investors don’t like uncertainty. And there was far too much uncertainty in the mortgage market for anything that wasn’t backed by the GSEs.

By the end of the month, a path for the future began to become clear as the government and the Fed set up mechanisms to allow mortgage lending and investing to continue without even more disruption. 

Eventually, the panic subsided and things started to return to some semblance of normal. But not before the entire business, from investors to lenders to servicers to borrowers and everyone else in between was shaken to their very core.

The panic, like the virus, spread seemingly uninhibited. And it nearly destroyed everything. All in just one month. 

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