The Financial Collapse Was In the Shadow Mortgage Market

Following the collapse of the housing market in 2007 and 2008, not only did home prices fall along with the mortgage-backed securities they were wrapped into, but so did real estate lending.

Between Q3 of 2008 and Q1 of 2012, real estate loans from all U.S. commercial banks fell for the first time in modern history, from $3.8 trillion to $3.5 trillion based on Federal Reserve data.

Since then, home prices have rebounded, returning to effectively where they would have been had the financial crisis never occurred. Similarly, real estate lending has also come back, but not to the same degree as it was pre-crisis.

Mortgage lending was so furious leading up to the crisis that banks lent out $3 for every dollar of assets in mortgage-backed securities. Following the financial collapse and outside of the pandemic, that lending has remained largely fixed at a rate of 2-to-1 and declining further.

The difference between lending two times versus three times the value is a trillion dollar difference of unsecuritized mortgage loans a year that have disappeared.

Collapse of the Non-GSE Secondary Market

One might think that the two numbers should be similar. Most residential real estate lending becomes securitized as mortgage-backed securities into the secondary market through the government-sponsored entities (GSEs)—Fannie Mae and Freddie Mac.

But the GSEs don’t buy all loans. They currently don’t buy subprime loans, jumbo loans, and other interest-only loans. They don’t buy reverse mortgages and no-documentation loans, like Alt-A loans.

At the time of the crisis, the GSEs were getting into some subprime lending, but according to a Washington Post article they had only made $3 billion worth of these deals by October of 2006.

Real estate loans that don’t get securitized by the GSEs—otherwise known as nonconforming loans—are traded in the non-GSE, or private, secondary market.

While most attention during the crisis was focused on the mortgage-backed securities that underpin the U.S. financial system, it was the private, non-GSE securities market that really crashed. These are markets for mortgage-backed securities run by the banks for investors, who might also be other banks.

Countrywide Financial may be the best example of how big the private secondary mortgage market was. Prior to its collapse, Countrywide was the largest home lender in the nation, and it accounted for 28 percent of single-family loans securitized by Fannie Mae and Freddie Mac in 2007.

At the time, Fannie Mae’s total loan portfolio—single-family and multifamily—was $403 billion. For Freddie Mac it was $80 billion. Countrywide therefore represented $135 billion in securitized loans, which is slightly more than what Countrywide lists in their Securities and Exchange filings as assets¹. Essentially, they only held onto assets that could be securitized by the GSEs.

Yet Countrywide’s total loan servicing portfolio was over $1.28 trillion—larger than the GSEs combined assets for all lenders. There were around $800 billion in real estate loans serviced by Countrywide alone that were not being securitized by the GSEs—loans not owned by Countrywide, but administered by them, possibly because Countrywide originated the loan.

As interest rates rose and the crash hit, securitization of subprime, jumbo, and Alt-A loans went from $1 to $2 trillion between 2004 and 2006 to around $100 billion according to a report from the Brookings Institute.

As a result, Countrywide’s ability to sell loans in the non-GSE market came to an abrupt halt according to a legal complaint by the Securities and Exchange Commission for insider trading and disclosure fraud. Yet the GSE secondary market was barely affected.

Countrywide was considered the face of the subprime meltdown, but Countrywide’s subprime asset portfolio was not that large. According to an Auburn University report on Countrywide, the company had accrued over $8 billion in subprime loans. They defaulted at a higher rate that those at other banks, but $8 billion is just a drop in the real estate market bucket.

While its subprime asset portfolio was not particularly large, it’s unknown how large their subprime loan servicing portfolio was—the subprime loans administered and maybe originated by Countrywide, but not owned by them as assets.

Countrywide would collapse and eventually be bought up by Bank of America for a small fraction of its previous value.

1. Correction: A previous version of this story only included the total value of Fannie Mae’s single-family housing loan portfolio, not single and multifamily. It has been updated accordingly.