The announcement that fully vaccinated individuals need no longer wear a mask in most cases is a significant turning point in the fight against COVID-19. With the pandemic beginning to fade it also means that the economy can increasingly get back to normal.
Something else has also happened, but this reality has generated few headlines and little recognition. In the past year the economy has taken a massive beating with millions of lay-offs, widespread business closures, and yet the financial system has done well.
Not marginally well, really well. So far, there just aren’t a lot of bank failures or foreclosures. Here’s why.
The banking system
There have been no runs on the banks and few worries about a massive financial blowout despite a pandemic that brought much of the economy to a halt. The banking system has performed exceptionally well, especially when compared with our previous economic disaster, the mortgage meltdown and its aftermath.
|Bank Failures by Year|
|Year||# of Banks||Assets|
|Sources: FDIC, RealtyTrac|
How do we explain the differing results?
We changed the rules. We told banks they needed more reserves and that they could no longer underwrite toxic mortgages. It turns out that regulation — properly done — can help us navigate financial minefields.
In 2008 the government saw the foreclosure meltdown as a top-down problem and set aside $700 billion for banks under the Troubled Asset Relief Program (TARP). Not all of the $700 billion was used, but the important point is that the government did not act with equal fervor to help flailing homeowners, millions of whom lost their homes to foreclosures and short-sales.
This time around the government forcefully moved to help ordinary citizens. Working from the bottom-up, an estimated $5.3 trillion went to the public in 2020 through such mechanisms as the Paycheck Protection Program (PPP), expanded unemployment benefits, tax incentives, and help for local governments. So far this year we have the $1.9 billion American Rescue Plan with millions of $1,400 checks as well as proposals to spend trillions more on infrastructure.
For most Americans the 2020 approach has been a hit. Unemployment claims topped 23 million last May, this May they’ve fallen to 3.7 million. Bank deposits increased by nearly $2 trillion during the past year and credit card debt fell.
Foreclosures and evictions
“A year ago much of the world faced gloomy economic forecasts but today the US is in relatively good shape,” said Rick Sharga, Executive Vice President with RealtyTrac.
“However, looming ahead we’ll need to exit from the eviction and foreclosure bans. How can we do that with as little harm as possible to tenants, landlords, real estate investors, homeowners, and lenders?”
The bans have reduced evictions and held foreclosures to bare minimums. More than $45 billion has been set aside by the government to help tenants, money that will also benefit landlords and lenders if used as intended. Under the just-passed American Rescue Plan, an additional $10 billion has been earmarked to assist homeowners facing foreclosure.
These set-asides are certainly a start, but the big question is whether more will be needed. We’ll know more in six months or a year.
The 2010 Dodd-Frank legislation removed excess risk from the mortgage system for borrowers, lenders, and investors. It said lenders could originate just about any mortgage product they wanted, however if they originated comfy, vanilla “qualified mortgages” (QM) then they were virtually immune to lawsuits. This was a huge attraction, and today it’s believed that about 99% of all mortgages are QM.
“Qualified mortgages” were generally defined as FHA and VA loans, conforming mortgages that Fannie Mae and Freddie Mac could buy, and portfolio loans that met certain standards. Mandatory arbitration, interest-only financing, balloon payments, and loan terms in excess of 30 years were all outside the qualified mortgage definition. Prepayment penalties were severely restricted.
Another risk-reducer requires lenders to verify that all borrowers had the ability to repay their loans (ATR). According to HSH.com, “if a lender fails to comply with ATR and the borrower can prove this in court, the lender could be liable for up to 3 years of the loan’s interest costs, any charges and fees the borrower paid and the borrower’s legal fees.”
Lenders still have the right to make non-qualifying mortgages (non-QM) under the new rules, but such loans cannot include prepayment penalties and lenders can be sued more easily. Jumbo mortgages are often an example of non-QM financing.
The result of Dodd-Frank is that borrowers have safer loans, investors have less risk, rates are lower because there is less risk, and with safer mortgages there are fewer foreclosures.
But what about profits? Did the new rules hurt lenders in 2020, a year when Freddie Mac said that mortgage rates averaged just 3.11%
According to the Mortgage Bankers Association (MBA), “independent mortgage banks and mortgage subsidiaries of chartered banks made an average profit of $4,202 on each loan they originated in 2020, up from $1,470 per loan in 2019.”
“A surge in housing and mortgage demand, record-low mortgage rates, and widening credit spreads translated into soaring net production profits that reached their highest levels since the inception of MBA’s annual report in 2008,” said Marina Walsh, MBA’s Vice President of Industry Analysis.
And what about 2021 and 2022? We just don’t know yet, but it will be interesting to watch.