The 2020 Mortgage Crisis Explained

What's up guys? It's Graham here. So lately I've been hearing a lot of talk about this upcoming mortgage crisis. Not to mention, pretty much every single news website in existence is mentioning it. So let's talk about it.

And instead of creating some sort of sensationalized video with scary music in the background, talking about how the mortgage crisis is gonna be the end of civilization as we know it, I'm going to be doing my best to explain objectively what the problem is, what's causing this, what this means for you and I, and whether or not I think this is going to be cause for concern.

I say this as someone who has nearly all of their money invested in real estate and rental properties, and uses loans and mortgages as leverage to better increase my cash flow. So is this something that we should all be worried about, or is it just another catchy headline that leads us absolutely nowhere other than clicking another article yet again from The Wall Street Journal?

Well, let's look at the research and find out. As usual, I put a lot of work into these videos to try to give you as best of a perspective as possible. So if you wouldn't mind, if you appreciate that, just destroying the like button because the YouTube algorithm says that's a good thing to do. It would help out my channel tremendously.

So with that said, with that out of the way, I really appreciate it. Thank you so much, and let's begin the video. If those not familiar, let me explain what this whole mortgage crisis is all about. Because this is quite different than what happened in 2008 when lenders were going and giving the worst loans imaginable to people who couldn't afford them, when they ended up foreclosing and then just crashing the entire market.

This one all starts with the $2 trillion dollar stimulus package that was just passed. And you guys know the saying, "No good deed goes unpunished," right? Well, I mean, in a way, that's kind of like what happened here. This recently passed stimulus package ended up giving significant relief to people and businesses in need of money, funding to hospitals and health care workers, and just a myriad of other packages.

One of which included the Federal Reserve going and buying mortgage-backed securities, which basically consists of the loans that you take out anytime you go and buy a home. So you think of the word security as another term for investment, and that investment is backed by the homes that they're based off of. So hence, mortgage-backed security.

It's basically a way to invest in a whole bunch of mortgages that are tied to people's houses. The banks go and sell these things off to free up some cash and also collect some money up front, kind of like a commission for basically going and getting you the loan.

Here's how that works: when you go to get a loan from a bank, let's say to go and buy a mansion, you go and get that ten million dollar loan. You use that to go and buy the house, and then you pay interest on that loan depending on the terms of the agreement.

But the bank where you got the loan just doesn't sit there for thirty years collecting a three and a half percent interest rate while you go and pay off your mortgage. That would just take way too long for the bank to make their money back and will tie up all of their money. Plus, banks don't have the cash on hand just to give out mortgages every single day to absolutely anyone who qualifies for one.

So instead, the banks just make money from all of these small fees associated with your loan. Then they neatly wrap it all up and sell it to an investor who holds those mortgages as an investment. That way, the bank gets their money back fairly quickly, they've made a little bit of money in the process, and someone else, like the investor, can get a safe and stable return on their money.

Seems like a fairly straightforward and honest operation, right? Well, what ended up happening is that during the crisis, the markets were falling. Uncertainty was all around us; people were not spending money, and banks were caught in the crossfire. They had all of these loans just packaged neatly, waiting to sell to an investor, but the problem was that when they went to hand them off to an investor, the investors were just like, "No, we're not gonna buy those right now. It's a bit too risky in the market, so we're just gonna be holding off. You keep those, and yeah, we're gonna hold off from buying any of those right now."

Now the bank is backed up with all of these loan applications and loans that they can't sell because there are no investors willing to buy them. In a way, it's a bit like the bank is constipated. They're backed up with all these loans that they can't get out.

So in a way for the bank to purge itself and relieve this pressure, what they did is they went back to the investors and they said, "Okay, investors, how about this? Any loans that we do right now, we'll just raise the interest rate. That way you can get a higher return and make you more likely to buy our loans."

So in order to get a higher interest rate, we're just going to go to all of our borrowers and we're gonna say, "Instead of giving you a loan for 3%, now your loan is 4%. And you over there, now your loan is 5%. And you over there, five and a half percent, there we go!"

Now the investors are going to go and buy our loans because now they get a higher return. Well, now that's good for the banks and it's good for the investors, but it's a big problem for anyone who's buying a home because either now they're paying a slightly higher interest rate or they're just not getting the loan altogether.

So the Federal Reserve saw this and saw borrowers having to pay above market rate for the loan because no investors were there to go and buy that loan, and they said, "Mortgage industry, no problem, no problem at all! We'll guarantee all of those loans. In fact, we'll buy all of those loans for you, no problem at all. We'll drive down the interest rate. Huh, we've got so much money; we're good. You guys are good, we're good."

But not really because here's what happened: when you go and apply for a home loan, you do what's called a rate lock on your mortgage, meaning you could go and lock in the quoted rates a few weeks before closing your mortgage, and that way you know exactly how much you're gonna end up paying.

But when you lock in a rate like this, the bank is agreeing to you that you are going to get that promised rate, but the bank doesn't know what the actual rate is gonna be at the time they actually close that loan.

So because the banks don't want to lose money in the event that interest rates change by the time you actually close the loan, the bank is going to hedge their investment by going and making the opposite bet of whatever you do.

It's kind of like betting on both red and black at the roulette table, knowing that if one of those bets loses, then most likely they’re gonna win on the other one, which would cancel it out entirely. Most of the time, they’re just gonna have the same amount of money that they started with.

So banks do this by shorting mortgage-backed securities, meaning that they’re betting the price of those securities is going to be going down. See, if those investments drop in value, meaning that interest rates are going up, then the lender ends up making money and can use that money to pay the loss of you locking in at a lower interest rate.

If that investment goes up in value, meaning that interest rates are going down, then the lender will lose money on that investment, but profit on the difference of the interest rate that you pay.

So either way in this situation, the lender can cover themselves in terms of any sort of fluctuation in price, and that way they don’t lose any money. Again, kind of like betting on both red and black through that table, and then of course hoping it doesn’t hit zero or double zero, but we’ll leave that part out.

However, when the Fed steps in and says, "Don't worry guys, we're gonna be guaranteeing all these loans, no problem here, let's keep it going," it drives interest rates down, causing the price of all these mortgage-backed securities to go up and causes banks to lose a lot of money on their short hedged positions, which is betting, of course, at the prices of those mortgage-backed securities are gonna be going down.

Now typically when something like this happens, a lender could counteract all of these losses by all of the new loans that they’re gonna be getting with lower interest rates. But where things get interesting is that these bets and hedges are made on margin, meaning that those losses might have to be paid back on very short notice, and things get bad enough.

Like I said, ordinarily a bank could write out these paper losses with all the new loans coming in, but as fewer people take out new loans to go and buy homes, and as more people cancel last minute after everything that’s happened, and as more people lose their jobs and can’t move forward with the purchase of their property, and not to mention as a flurry of people go in to try to refinance their loans to get a lower interest rate, the banks are left holding a bunch of hedged investments on margin with fewer loans coming in to help offset those costs.

So banks have to go and put up more capital to offset those losses. That means less money they could lend to consumers, and from there, more problems arise when less money flows back into the economy from people like you and I going and taking out loans.

But then there is also one more layer of complexity with all of this, somewhat on topic of what we've already been talking about, and I've seen a lot of articles lately going and addressing this, and that would be the missed mortgage payments part of this relief package.

It includes potential mortgage payment forbearance of up to 180 days, with another possible extension of an additional 180 days beyond that. Meaning that right now if you have a mortgage and your income and ability to repay that loan has been directly affected by the illness, you could take a temporary pause for up to 180 days or more if you have a federally backed mortgage, which is pretty much the vast majority of loans out there.

However, even though you are not making payments on your mortgage, your mortgage servicer, or the one who facilitates and processes your payment, is on the hook for being able to pay what you don't. They’re still legally obligated to keep the money flowing into these mortgage-backed securities, the same ones who were bought by investors who wanted a safe and stable return.

So in a weird way, these mortgage servicers are a bit like your mortgage guarantor, in which if you don’t pay, they will still have to pay. That right there poses another potential problem in that if a significant amount of people stopped making their mortgage payments, how much money are these mortgage servicers going to be out, and how long can they float during a time where maybe a lot of people are not paying their mortgages?

Needless to say, if everything just recovers shortly in a few weeks and the entire economy comes roaring back in like a month from now, it's probably not gonna be that big of a deal. But if this persists for many more months on end, how bad can it possibly get?

Well, here are my thoughts, coming from someone who's probably very unqualified to talk about anything related to this, but I will go and do so and speak my opinion because this is YouTube, and this is all just for entertainment purposes only, not investment advice.

And yeah, here is what I think. First of all, the majority of loans out there are known as what's called conventional conforming loans. This means that the loan conforms to specific guidelines, giving you a better interest rate, making sure you don't borrow too much money.

These types of loans are much easier to sell on the secondary market, and because they're conforming, they meet the guidelines of Freddie Mae and Fannie Mac, which are two government-sponsored agencies that buy and sell and otherwise guarantee these mortgages.

So in a way, Fannie Mae and Freddie Mac just say, "Hey banks, just give us some loans that meet this criteria. If you bring us this sort of loan we like it; those are good investments, safe for us. We're just gonna buy them, so bring us these types of loans. Anything you find like this, don't worry, we got it covered." And by following those guidelines, it pretty much guarantees that they have a buyer for the loan. It gives them much more liquidity, and it gives them the ability to go out and issue more loans.

And you, in turn, yes, yes you, the one who smashed the like button for the YouTube algorithm, you in turn would be able to get a better interest rate on your loan because you're a safer borrower. So I really believe for the majority of people out there, all of this is really not that big of a concern.

If you already have a home and you already have a mortgage, your biggest change might be that potentially one day you end up making your mortgage payment to someone else instead of who you're making it to right now, and that's about it.

However, where this could affect you is in the short-term for anyone who's looking to buy a home or finance their home, get a loan, or potentially sell their home. That's because if you're in the market to get a home right now, lenders are probably going to be way more strict about who they give a loan to. They’re most likely going to want more money down, a higher credit score, lower debt to income, not to mention they might want you to pay a slightly higher interest rate due to everything going on right now.

And also given how much demand there is at this point for really cheap money. Now on the bright side, depending on how you look at this, this also might mean that a large portion of the market out there can't qualify for a loan, meaning you now might have less competition when going and shopping for a house.

But of course, we also have to acknowledge that if people lose their jobs, they can’t make their mortgage payments, they can’t get enough relief, and they can’t cash flow, and the property that they bought then only makes sense as an Airbnb vacation rental, then we might start to see some foreclosures popping up over the next six to twelve months as the tide pulls back and people fall further behind on payments.

If you're in a position to invest your money right now, then sure, you might end up getting a good deal in the future. And if you're selling a home, then it might be slightly more difficult to get the asking price for your home, not to mention that there could be fewer buyers out there that would qualify for the loan.

But I think most likely this is going to impact smaller, more vulnerable banks than it is going to affect you and I directly. Again, this is just my opinion here, so don't comment down below and be like, "But Graham, you don't know what you're talking about. This is the bear market that I've been saying, the bear market for ten years now, and now it's happening, and I'm right. No other opinion matters!" Dislike.

I said again, this is just my perspective. In my opinion, the current mortgage crisis is gonna be rather short-term and is probably going to even itself out in a few months, if not sooner. Not to mention, a few days ago Ginnie Mae announced that they would be providing short-term money for lenders who are having difficulties with margin calls.

At this point, realistically, the Fed just seems like they're on track to bail out anyone who potentially even needs it. So as awful as this is for me to say, and believe me, I don't like saying this, but I do feel a little bit safer knowing that if anything is to get that bad, I feel somewhat confident that the Fed would step in and just bail anybody out and just continue printing money, and just we wouldn't have the problem anymore.

Because really, at this point, what's another 100 or 200 billion dollars? Like that's play money for the Fed at this point; they flush that down the toilet every day. So what's a little bit more?

So I think largely for most people out there, they're going to be unaffected by this. Specifically, that's not to say that you shouldn't have any concerns if you own a rental property and your tenant stops paying, or you fall ill or lose your job and can't make your mortgage payments. In situations like that, you should absolutely bring it up to your lender and see if you could seek any forbearance on your mortgage.

As far as March and liquidity for lenders, I have a feeling it's not really gonna make much of a difference for anyone in the short-term, as most likely this is going to be resolved in a few weeks to maybe a few months.

But hey, you know what? That's my opinion; it’s just what I think based off the research that I have done. And hey, if you come to a different conclusion, let me know down below in the comments as you guys know I pretty much read them all.

So if you have a differing opinion, or you think this is a bigger deal or less of a deal, or you think this is gonna get better or worse, just let me know down below in the comments.

So now, at the very least, I hope that provides you with more explanation and context of what's been going on, so the next time you read a headline about the mortgage crisis, you could have a better and deeper understanding of what's going on and how it affects everybody involved.

So with that said, you guys, thank you so much for watching. I really appreciate it. As always, if you guys enjoy videos like this, make sure to hit the like button, subscribe, hit the notification bell.

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Thank you so much for watching, and until next time.