Amid the pandemic-influenced economic downturn, the warning issued by two campus professors about a potential crisis in the mortgage industry in their 2018 paper may come to fruition.
Published by Haas School of Business professors Richard Stanton and Nancy Wallace, the paper states that narratives surrounding the 2008 recession typically focus on the “housing bubble,” while the role of nonbank financial institutions in the crisis is understated. According to Wallace, nonbanks — such as Quicken Loans and Freedom Mortgage — that aid borrowers in the home loan process are particularly vulnerable to liquidity crises due to their reliance on short-term credit.
“I think the situation is extremely serious, a looming nightmare,” Wallace said in a Berkeley Haas article.
Unlike traditional mortgage lending institutions such as commercial banks, nonbanks are lightly regulated, with mortgage origination and servicing often being their only line of business, according to the article.
Wallace added in the article that the pandemic-induced shutdown has left millions of people unable to pay their mortgages. According to Wallace, the Coronavirus Aid, Relief and Economic Security, or CARES, Act passed in March allows home loan borrowers a forbearance of up to 360 days on their mortgages.
“Since the nonbanks are a large component of the mortgage market, they employ many people, and they enable the smooth operation of the housing market, this liquidity shock is potentially a very big problem,” Wallace said in an email.
The short-term credit that nonbanks often rely on, known as warehouse lines of credit, is provided by commercial and investment banks. While mortgage borrowers are allowed to delay mortgage payments, according to Wallace, nonbanks are still required to make payments on their lines of credit despite not receiving payments from their clients.
This could leave many nonbanks unable to make payments on their lines of credit, she added in the article. Additionally, the paper reports that commercial and investment banks can tighten or withdraw warehouse lines of credit entirely. These strains on credit could drive nonbanks out of business.
Another major cause for concern is the growth of the nonbank sector since the recession, according to Wallace. In 2016, nonbanks made up nearly half of all mortgage originations, up from only about 20% in 2007, the paper reports.
Wallace added in the email that a bailout for nonbanks is necessary to alleviate the situation. Federal coronavirus-related relief funds and bailouts have yet to include relief for nonbanks, Wallace noted in the article.
“The fundamental problem is the same, since as in 2007 we also saw large scale bankruptcy amongst nonbank lenders,” Wallace said in the email. “One difference is that these firms were a smaller part of the mortgage market pre-2008 crisis.”