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Residential Mortgage Lending: Principles and Practices, 6e Chapter 3 Role of Residential Mortgage Lending in the Economy

© 2012 Cengage Learning Objectives After completing this chapter, you should be able to: – Explain how changes in the business cycle affect real estate sales activity and mortgage lending. – Explain the economic stimulus that housing and home sales have on the economy – Understand how demographics influence housing demand and homeownership rates – Understand how consumer savings impacts the ability for lenders to provide funds for mortgage loans – Cite the impact of the government’s deficit spending on interest rates and the supply of capital. – Identify three ways the Federal Reserve exercises monetary control – Compare and contrast the functions of financial intermediaries, mortgage lenders, and mortgage investors. – Explain why Money Market Certificates (MMCs) failed to correct the problem brought about by inflation and excessive credit demand.

© 2012 Cengage Learning RESIDENTIAL MORTGAGE DEBT 2002, outstanding single-family residential debt in the United States exceeded $6.4 trillion. This figure almost doubled in five years, peaking at more than $11.1 trillion in At the end of 2009, after a significant recession and “correction” (decrease) in housing values, more than $10.7million

© 2012 Cengage Learning Lower Interest Rates Make Housing More Affordable: Monthly Principal and Interest Payment on a 30-Year Mortgage

© 2012 Cengage Learning ECONOMIC STIMULUS OF HOUSING Housing and mortgage-lending activity stimulates the economy directly through the home sale transaction and indirectly through related purchases and expenditures that ripple through the economy after the sale.

© 2012 Cengage Learning ECONOMIC STIMULUS OF HOUSING Economic commentators contend that from the time of the Great Depression the housing, construction, and related sectors (e.g., real estate sales, financing, home furnishing, taxes) are among the most important integrals of the engine that powers the United States economy.

© 2012 Cengage Learning ECONOMIC STIMULUS OF HOUSING Economists conclude that housing and related sectors account for, on average, between 15 and 20 percent of the gross domestic product (GDP).

© 2012 Cengage Learning Average Existing Home Price 2007–2010

© 2012 Cengage Learning Economic and Social Value of Housing According to the Federal Reserve, the market value of all homes owned by U.S. households grew to a record $10 trillion in 2000, and doubled to more than $22.6 trillion by The market value of housing on a national basis plummeted 27 percent or more in just two years, to $16.4 trillion in 1Q2009, and rebounded slightly to more than $17 trillion as of 2Q2010.

© 2012 Cengage Learning U.S. Homeownership Rate 1900 – % – 48% 1960 low 60% level for next 30 years 1990’s exceeded 64% 2004 Historic High of 69.2% 2010 dropped to 66.9%

© 2012 Cengage Learning Demographic forces in the long term will increase or lower housing demand. Couples reaching their home-buying years, new immigrants, and certain minority groups increase demand for housing.

© 2012 Cengage Learning These groups are expected to form new households at a rate of more than one million per year for the next decade. Financing this demand for housing will challenge the housing finance system, but will also provide an opportunity for growth in residential mortgage lending.

© 2012 Cengage Learning IMPORTANCE OF SAVINGS TO HOUSING Funds required for capital formation are derived primarily from the savings of individuals and businesses. Savings Rates Decline in the Savings Rate Capital markets and the money market

© 2012 Cengage Learning Users of Credit Business demand Consumer demand Government demand

© 2012 Cengage Learning Interest Rates Competition for Funds Public Debt versus Private Debt Monetary Policy and Interest Rates The Federal Reserve Bank System Countercyclical Nature of Real Estate

© 2012 Cengage Learning FINANCIAL INTERMEDIARIES ● Commercial banks ● Savings and loan institutions ● Mortgage companies ● Credit unions ● Mutual savings banks

© 2012 Cengage Learning FINANCIAL INTERMEDIARIES ● Life insurance companies ● Finance companies ● Investment companies ● Pension funds ● Money market funds ● Stockbrokers

© 2012 Cengage Learning MORTGAGE LENDERS AND THE PRIMARY MORTGAGE MARKET ● Mortgage bankers ● Mortgage brokers ● Commercial banks ● Savings and loan institutions ● Savings banks ● Credit unions ● Housing finance agencies

© 2012 Cengage Learning Recent Trends ● Who the lenders are in the primary market ● How residential loans are originated ● How technology is used to enhance profits ● How funds for mortgages are generated

© 2012 Cengage Learning Recent Trends ● How interest rates are calculated ● How mortgages are sold and securitized ● How mortgages are serviced and by whom ● How borrowers are qualified ● Who the mortgage investors are in the secondary markets

© 2012 Cengage Learning Mortgage Revenue Bonds (MRBs) Mortgage Credit Certificates (MCCs) Builder Bonds

© 2012 Cengage Learning What Do You Think? Real estate and mortgage lending are a major part of the American economy. Examine and explain the magnitude of their involvement in the economy. Real estate and mortgage lending are significantly impacted by changes in the economy, especially interest rates. What was the impact on mortgage lending of the dramatic drop in interest rates in 2001–2002? Why did interest rates drop so much?

© 2012 Cengage Learning What Do You Think? What is the difference between financial intermediaries, mortgage lenders, and mortgage investors? How does “the Fed” attempt to manage the economy? What tools are most important? As a general rule, where does the money for residential mortgage lending come from? How do demographic forces impact real estate and the mortgage markets?

© 2012 Cengage Learning Check Your Understanding Savings of individuals make up an insignificant part of the funds required by the financial market. Mortgage lending is part of the capital market. As a general rule, financial intermediaries can earn higher yields on investments than individuals can. Money market certificates (MMCs) have increased savings inflows to banks and thrifts.

© 2012 Cengage Learning Check Your Understanding The Federal Reserve is responsible for fiscal and monetary control. Low interest rates usually do not stimulate the housing market because too many people are out of work. The primary risk to portfolio lenders is interest rate risk. The term financial intermediary refers to the person who is a middle man between financial institutions. The value of all homes in the U.S. is approximately $17 trillion.