A repeat of 1989???

Well the news on the housing market and the mortgage bankers is grim today.

Countrywide has tapped its entire $11.5 billion bank line to maintain liquidity. That means they are basically shut out from the short term and long term capital markets. No one wants to lend them money because of the fear they declare bankruptcy. Of course the banks don't like this either but they have clauses in their agreements to protect themselves.

This does not mean Countrywide will go BK, rather it means they are facing a credit squeeze or rather a cash squeeze. Countrywide makes mortgages and then sells them on the secondary market while retaining the servicing rights. So many people make their mortgage payments to Countrywide, the actual loan has been grouped with others and sold to the bond funds or to FANY MAE or FREDDY MAC who then resell them to the secondary market. If you have a bond mutual fund, there is a good chance you own some of the packaged mortgages. If there are a 1,000 mortgages in a bundle and one goes bad, the return for the group will be less but everyone should still make money. The problem is when a large number of the mortgages default and the investors start to lose principle. Some of the big buyers of the mortgages (insurance companies) often have clauses in the purchase agreements to force the mortgage bankers to repurchase the mortgage bonds if a certain percentage go bad and reimburse the insurance company for the losses incurred. This causes the mortgage company to lose liquidity as they have to take back mortgages and can't make new loans which reduces their income while also having to absorb the loans that go bad.

But with buyers of mortgage back securities being picky on what type of mortgages they will buy, no more sub-prime loans, the number of mortgages being generated has fallen and thus reducing the income to the mortgage banks. The banks also have to set aside more capital for loan loss reserves and if too many people panic, they could be overwhelmed and have to go BK. That is the exposure to Countrywide and other mortgage banks. Its not that they have made so many bad loans, but rather so many people are scared, they dump good mortgages and the mortgage bankers run out of liquidity.

The same thing happened to banks in the 1930s in the US. Banks only hold on to a fraction of their total reserves because they turn around and lend them out to make money. Well when too many people wanted their money out of the bank, the bank runs out of reserves and folds, even though it was profitable and well managed. That was one of the reasons for the FDIC back in the 1930s. To make sure a bank had the liquidity to handle a sudden surge of withdrawals in the short term without causing economic ruin in the long term.

Mortgage bankers are not covered by FDIC insurance (which is a good thing I think) but it also makes them more susceptible to panic withdrawals when the market goes sour. Hopefully the well run companies (like Countrywide) have set up enough contingent funding to ride out the panic and can weather the storm.

For anyone who has a Countrywide mortgage, what happens if the worst happens and it goes BK? Nothing. The company you make the payments too may change or may not but the terms and conditions of your mortgage will not be effected.