Mortgage Product Pipeline
Let’s get the most important bit out of the way first: civilians think that a mortgage is a loan between a bank and a customer, and think of it primarily as services work (to the extent they think of it at all). This is a materially incorrect worldview, ...
Capital Thinking · Issue #1022 · View online
Let’s get the most important bit out of the way first: civilians think that a mortgage is a loan between a bank and a customer, and think of it primarily as services work (to the extent they think of it at all).
This is a materially incorrect worldview, which drives much confusion about how the industry (and mortgages) function, both among people who can’t be expected to know better (customers) and people who probably could (regulators and journalists, among many others).
Mortgages are a manufactured product
Why is it so hard for entrepreneurs to get mortgages?
Why did the address I send my payment to change? Why don’t most banks own mortgages anymore? Why is there a thriving economy of small specialist lenders locally who only do mortgages?
Why is a 30-year fixed rate mortgage available at all?
Welcome to the wild and wooly world for mortgages in the United States: the world’s most important manufactured product that virtually no users understand.
For starters, virtually no one outside of the value chain considers a mortgage a manufactured product at all. Most people who own homes think they were the primary customer of the mortgage, but that’s not true.
(Apologies in advance for this being a very specifically U.S. flavored issue of this publication. While practice in some nations—Japan comes to mind—is trending in the direction of U.S. practice, the world’s largest and most sophisticated mortgage market is also very quirky, as a result of a hundred years of policy decisions with societal-level impact.
Trying to address multiple nations’ takes on this instrument would make this issue the length of a small encyclopedia. Also, for simplicity, we’ll largely be looking at residential mortgages rather than commercial.)
Mortgages are a manufactured product:
Let’s get the most important bit out of the way first: civilians think that a mortgage is a loan between a bank and a customer, and think of it primarily as services work (to the extent they think of it at all).
This is a materially incorrect worldview, which drives much confusion about how the industry (and mortgages) function, both among people who can’t be expected to know better (customers) and people who probably could (regulators and journalists, among many others).
A mortgage is a product, which is built by specialist workers using an immense and costly capital edifice, to be sold into a supply chain for consumers of that product.
It incidentally happens to involve a house and a loan, but those two facts do not drive most behaviors of the mortgage industry. The structure of the manufacturing process, and the consuming supply chain, do.
If it helps you to visualize this, think of a widget going into some hyperspecialized and boring bit of capitalism.
Electronic flow meters, for example.
Somewhere, in fact in many somewheres, there exists a factory of people who do nothing but assemble electronic flow meters. These do exactly what they say on the tin; they measure flows of liquids or gasses using electric means.
There are a lot of them in parts of the economy which push things through physical pipes, whether that is New York’s sanitation department or a steel smelter.
It would be a very bad thing for the electronic flow meter factory to sell flow meters that didn’t meter flow accurately. Their consumers would hate that. Cakes would taste bad. Buildings would explode.
If you replaced your current mental model for mortgages with:
“it’s like a paper electronic flow meter for money, possibly with less paper these days”, it would improve your ability to understand the mortgage industry. The analogy is less about providing visibility into the contents of pipes (though mortgages must do that) and more “highly specialized manufactured widget that the entire world sits downstream of.”
Who manufactures mortgages?
Mortgages are written by originators.
The first and most thorough misconception the public has about mortgages is that they’re written by lenders. Originators can be lenders, and historically generally were, but these days they generally are not.
The people who make electronic flow meters do not also run the cake-baking factory as a fun hobby. Those are entirely different skillsets. They sell the thing they make, through a fairly complex value chain, to the cake-baking factory.
Of the top 15 mortgage originators in the U.S., only four are banks (Bank of America, Chase, U.S. Bank, and Wells Fargo), and most of those banks’ mortgage volume originate-for-sale rather than originate-to-lend.
The remainder are all pure-play mortgage firms, some of which you’ve probably heard of due to direct-to-consumer marketing (RocketMortgage, Guaranteed Rate, etc) and some of which are more obscure (despite writing tens of billions of dollars of mortgages). This is due to a difference in operational models for them; we’ll get to that in a later issue.
So who actually has their hands on the tools in the mortgage factory?
Every mortgage is a collaboration between:
The front office: A sales professional, called a loan officer by convention (and usually referred to in the industry as “a producer”).
Their job is to interface with the home buyer, educate them on the most complicated and high-stakes financial decision they’ll have to make in their lives, and project manage the financial side of a real estate close. This will include a backbreaking amount of passing documents to…
The back office: Approximately 1.5 professionals per loan officer, who are responsible for making sure electronic flow meters are properly calibrated. Oops, wrong side of the analogy.
No, they are responsible for making sure that the physical instantiation of the mortgage, 700 pages of documents or so, will pass the strict acceptance tests of the value chain that sells mortgages to end-users of mortgages.
The industry operates, as many people who have interacted with it can attest, in a disturbingly artisanal manner for a trillion dollar manufacturing sector which props up a huge portion of the economy.
As the person buying a house, you care tremendously about the professional skill levels of your loan officer in a way which you never really care about the professional skill levels of the person who assembled your phone.
Who buys mortgages?
In a typical manufacturing supply chain, the box with the thing in it passes through different hands, or the thing gets incorporated into increasingly complex assemblies. In the mortgage supply chain, the thing gets split apart and (sometimes) repackaged into other things.
The manufactured product which is a mortgage is a collection of risks.
The finance industry and government in the United States, to be more efficient and accomplish a long list of social goals, has successfully disaggregated many of those risks.
Different risks are bought by different entities.
The risk of non-payment
As a policy decision, the United States has effectively socialized most of the market for the risk of non-payment of mortgages, in the interests of making home ownership more predictably available. (Whether this makes it cheaper or more expensive on net is a complicated question to answer.)
The mechanism for this are the GSEs (government-sponsored entities), like Fannie Mae, Ginnie Mae, Freddy Mac, and the Federal Home Loans Bank.
These are all privately owned entities who have CEOs, shareholders, etc etc, but they’re also policy arms of the U.S. federal government and everyone knows it. (If there was any ambiguity about that, and there was very little, the financial crisis dispelled it.)
The business model of the GSEs rounds to this: they publish the specifications for the mortgage industry.
This lets you know that the electronic flow meter will work as advertised and not blow up the factory you install it in. A mortgage which fits their specifications is called “conforming.” Buyers of a conforming mortgage need inquire no further about the 700 pages of documents.
They treat mortgages as black boxes with some observable metadata to them.
