Credit Crunch Threatens to Boost Mortgage Interest Rates

The good news for consumers is that mortgage rates are at an all-time low. The bad news is, there may not be much money to lend.

A major source of financing for mortgage bankers, known as "warehouse lending," has nearly dried up over the past year. As a result, mortgage bankers are getting tons of customers seeking to take advantage of the low rates, but may lack adequate funds to meet the demand. This could end up driving mortgage interest rates higher, despite the Fed's recent aggressive moves to bring them down, and put a further drag on the struggling housing market.

Mortgage banks account for approximately 4 out of every 10 home loans written in the United States, according to the Warehouse Lending Project, a Washington, D.C.- based coalition of mortgage lenders. Because they are not licensed to take deposits, mortgage banks borrow money from larger financial institutions to lend to their customers, then sell the mortgages to other investors in order to restore their own lines of credit.

Credit pool shrinks nearly 90 percent in past year

The problem is that the available pool of credit for warehouse lending has shrunk drastically over the past year, according to the Mortgage Bankers Association, from $200 billion to $25 billion. In addition to the ongoing credit crunch that is hurting lending overall, many large lenders have simply gotten out of the warehouse lending business, among them National City, J.P. Morgan Chase and Guaranty Bank. To free up credit, the Warehouse Lending Project is urging the federal government to allow subsidized lenders Fannie Mae and Freddie Mac to get into the warehouse lending game. The Federal Housing Administration, which regulates the two mega-lenders, has reportedly asked industry representatives, including the Mortgage Bankers Association, to draft a detailed plan by which Fannie Mae and Freddie Mac can help restore warehouse lending.

Industry asked to develop proposal

The regulator has asked representatives of mortgage banks, including the Mortgage Bankers Association, to come up with a detailed plan for Fannie and Freddie to help mortgage banks get credit. John Courson, chief executive officer of the association, said in an interview that the plan should be ready to be presented to the regulator within about a week. One possibility is that Fannie and Freddie will guarantee debt issued by warehouse lenders, making it easier for them to provide financing to mortgage banks.

Not everyone is enthusiastic about the idea. Stephen Spruiell, a writer for National Review Online, argues that warehouse lending was a significant factor in the housing bubble of the past decade, fueling a "glut of consumer debt that has now exploded into a full-blown financial crisis." He contends that the reduction in warehouse lenders from a reported 115 in 2005 to fewer than 30 today merely represents a return to the pre-bubble norm, when lending was dominated by banks lending their own capital, rather than borrowing the capital of others.

Nonetheless, there are signs that other major banks may see opportunity in picking up the slack left by the ones that have gotten out of the warehouse lending business. Bloomberg News has reported that Wells Fargo plans to open a new unit that will provide up to $4 billion in warehouse lending credit, although company representatives declined to comment on the report. It remains to be seen whether other large lenders will do.