Post by unlawflcombatnt on Sept 22, 2007 3:18:34 GMT -6
Below is an excellent passage from Jim Jubak's latest article. It describes the synchrony between banks, mortgage originators, and capital markets -- and how they've contributed to the decline of the U.S. economy.
"In the good old days, the days when Jimmy Stewart ran the Bailey Building & Loan Association in Bedford Falls, S&Ls and banks took in money from depositors and then lent out the cash from these savings accounts as mortgages. And, quaintly enough, the banks even held on to the mortgages, collecting monthly payments for 30 years before retiring the debts.
Writing new mortgages depended on money flowing in from new deposits, from monthly mortgage payments and from the occasional early payoff of a mortgage.
The model at Northern Rock -- and at Countrywide Financial and its U.S. peers -- is very different. Yes, some of the money lent out in mortgages may come from deposits, but most of the cash comes from the capital markets, where mortgage lenders of every stripe tap buyers of commercial paper for new cash. Mortgages don't sit on the books until they mature, and originating companies actually collect very few monthly payments on these debts. Instead, the mortgages are sold off and then turned into asset-backed securities of various flavors.
Lending faster and faster
This system supercharges the returns that financial institutions can make in the mortgage business. A company that originates a mortgage can sell it off in a matter of weeks, regain its capital (plus a fee for originating the mortgage and, if interest rates and the financial markets break right, a profit on the sale of the mortgage) and then, having freed up its capital, originate another mortgage.
That works just fine as long as the capital markets are willing to lend the mortgage companies the short-term funds that they will turn into long-term mortgages, and as long as the capital markets are willing to buy the securitized mortgages so that the mortgage lender can get the mortgages it has written off its hands and free up its capital again.
This system contains the seeds of its own destruction, however. It encourages lenders to run faster and faster. The more money they can put out in mortgages, the more mortgages they can sell or securitize, the more money they can free up for new mortgages, the more mortgages they can write, and on and on. Growth in deposits can't possibly keep up with this growth in the mortgage portfolio. So leverage at the lending institution grows and grows...."
"In the good old days, the days when Jimmy Stewart ran the Bailey Building & Loan Association in Bedford Falls, S&Ls and banks took in money from depositors and then lent out the cash from these savings accounts as mortgages. And, quaintly enough, the banks even held on to the mortgages, collecting monthly payments for 30 years before retiring the debts.
Writing new mortgages depended on money flowing in from new deposits, from monthly mortgage payments and from the occasional early payoff of a mortgage.
The model at Northern Rock -- and at Countrywide Financial and its U.S. peers -- is very different. Yes, some of the money lent out in mortgages may come from deposits, but most of the cash comes from the capital markets, where mortgage lenders of every stripe tap buyers of commercial paper for new cash. Mortgages don't sit on the books until they mature, and originating companies actually collect very few monthly payments on these debts. Instead, the mortgages are sold off and then turned into asset-backed securities of various flavors.
Lending faster and faster
This system supercharges the returns that financial institutions can make in the mortgage business. A company that originates a mortgage can sell it off in a matter of weeks, regain its capital (plus a fee for originating the mortgage and, if interest rates and the financial markets break right, a profit on the sale of the mortgage) and then, having freed up its capital, originate another mortgage.
That works just fine as long as the capital markets are willing to lend the mortgage companies the short-term funds that they will turn into long-term mortgages, and as long as the capital markets are willing to buy the securitized mortgages so that the mortgage lender can get the mortgages it has written off its hands and free up its capital again.
This system contains the seeds of its own destruction, however. It encourages lenders to run faster and faster. The more money they can put out in mortgages, the more mortgages they can sell or securitize, the more money they can free up for new mortgages, the more mortgages they can write, and on and on. Growth in deposits can't possibly keep up with this growth in the mortgage portfolio. So leverage at the lending institution grows and grows...."