Overview of The Mortgage Market

With all that’s been written over the last few months about the mortgage market we need to step back and look at all the workings of this market. One obvious conclusion that can be made from what we’re reading is that the market is much more complicated than anyone ever imagined. In this respect the news media has done a fine job. On the other hand, by focusing on one or two issues, the media is creating the condition that will draw the reader to conclusions that may not be valid.

What I want to accomplish over the next few weeks is to give you an overview of how each player fits into the mortgage market and how the actions of each player impact the actions of all the other players.

The financial marketplace, which includes the mortgage market, can be best described as an ecosystem. Just as we now recognize that driving a car not only depletes the world’s oil supply is also impacts the temperature in Antarctica which in turns impacts the temperature of the oceans which in turn has an impact on the seacoasts around the world. As in the global climate, the decisions made by every player in the mortgage process, from the applicant, through the banks, the government and every step in between will have an effect on the overall process.

When a scientist or engineer looks to address a complex interaction such as what I’m describing here they will start by analyzing each component by itself. From there they will determine how the components impact the others with the ultimate goal of building as complete a model of the workings of the system as possible. This method of analysis is what I will be using in this study of the mortgage market.

I am going to begin with identifying each player in the process. From there, I will describe the problems each faces and the directions that can be chosen. I will be identifying the pros and cons of the various choices and the motivations that are behind each decision. This is not a witch-hunt; I’m not looking to accuse any one player as the cause of the mortgage meltdown we are now dealing with. The goal here is to gain a better understanding of how decisions are made at each step.

The players in the mortgage market are:
The applicant – the person looking for a mortgage.
The originator – the individual working for a broker or lender who is the source of information for the applicant.
The broker – a middleman that works with the applicant to find a lender that will commit and fund the mortgage.
The lender – the entity who commits to and funds the mortgage.
The wholesaler – an entity that doesn’t deal directly with the applicant but funds mortgages for the lender or broker.
Wall Street – we will use this term to encompass all the entities that package mortgages, securitize the package and then sell securities to investors.
The investors – an entity that invest money in order to get a return that is reflective of the amount of risk it is taking.
The Rating Agency – An entity that is in the business of evaluating the risk that a particular investment has. The investor looks to this rating as an aid in determining what investment to make.
The GSE – Government Sponsored Entity, chartered by the Federal Government for the purpose of supply liquidity to the mortgage market and to help more Americans become homeowners.
The Government – All levels of elected leadership whose purpose is to increase the well being of each citizen they govern.

Entities can play multiple roles in the mortgage market. For instance a commercial bank can be a lender (writing mortgages directly), a wholesaler (taking applications through mortgage brokers and other lenders), a broker (by placing mortgages that do not fit their standards with other lenders), a wall street firm (handling securitization) and at the same time act as an investor (through purchasing securities).

When I am discussing players I will not be talking about specific entities but positions in the industry. Each player has a different prospective on the market. For example, the applicant simply wants to borrow money at the lowest cost that fits his needs whereas the investor is looking for highest rate of return with the lowest risk. No decision is pure, that is, every decision will have both positive and negative results. A decision made with the best of intentions can suffer from the law “of unexpected consequences” turning a good idea terribly bad. The mortgage industry has felt the effects of this law more times than anyone wants to count.

You’ll see several examples as you continue to read this blog.