Certain MBS investors finance their MBS purchases with short-term funding that is often obtained from the same banks that fund the mortgage finance companies. Mortgage companies obtain short-term financing to make these mortgages from commercial or investment banks and obtain longer-term financing by selling the mortgages to securitization trusts that issue MBS. Mortgage borrowers borrow money to purchase or refinance homes from mortgage finance companies (referred to herein as “mortgage companies”). Banks are also subject to liquidity pressures, but unlike nonbanks, banks can obtain liquidity from the Federal Home Loan Banks and the Federal Reserve System.įigure 1 shows a stylized schematic of the shadow mortgage banking system. 4 4 Financial Accounts of the United States, Table L.218. About 70% of outstanding mortgages were funded through securitization as of September 30, 2021. I focus on the shadow mortgage banking system that delivers mortgage credit to borrowers through mortgage finance companies and securitization markets rather than through banks. 1.1 Liquidity and the shadow mortgage banking system In the next sections, I describe the shadow mortgage banking system and its liquidity vulnerabilities, summarize some of the tumult in the mortgage market in 2020 and the associated government interventions, and then trace out how this tumult affected the liquidity vulnerabilities of mortgage borrowers, mortgage finance companies, and mortgage-backed securities (MBS) investors. To preview my conclusions, I find that the mortgage market remains vulnerable to liquidity pressures, but these strains were mitigated in 2020 by reforms to the mortgage system since the GFC, the heavy government footprint in the mortgage market, and strong house prices.
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In this article, I update that work to explore whether liquidity strains emerged in the COVID-19 crisis as they did in the GFC. In addition to these factors, in earlier work (Kim et al., 2018), my co-authors and I highlighted the fact that the mortgage market is vulnerable to liquidity pressures at times of strain. In the years before the GFC, the mortgage market was plagued with shoddy underwriting, faulty credit-rating models, unsustainable leverage throughout the financial system, plunging house prices, and fraud. A major difference, of course, is that the GFC originated in part in the mortgage market. However, the mortgage market imploded in the GFC, whereas it survived the COVID-19 crisis mostly intact. 3 3 Federal Reserve Bank of Philadelphia ( 2022). By August 2020, 5.8% of borrowers had not made a payment on their mortgages for at least 3 months, up sharply from 1.7% in February 2020 but still below the GFC peak of 8.6% in January 2010. 2 2 US Bureau of Labor Statistics, Unemployment Rate, seasonally adjusted. The unemployment rate reached almost 15% in April 2020, relative to its GFC peak of 10% in October 2009. Data are from Chicago Board Options Exchange (CBOE Volatility Index: VIX ), retrieved from FRED, Federal Reserve Bank of St. 1 1 Long-run average measured from January 1, 1990, to December 31, 2021. The Volatility Index (VIX), a gauge of uncertainty in financial markets, spiked at 82.7 on March 16, 2020, higher than its GFC peak of 80.1 on October 27, 2008, and well above its long-run median of 17.6. Both periods were marked by extreme dislocations in financial markets and the broader economy. The mortgage market came under enormous strain in both the Global Financial Crisis (GFC) and the COVID-19 crisis.