house celebrateYou’re on the lawn of a 2,200 square foot house.  You’re sipping cold water from those tiny 8 oz bottles your Realtor gave you at the beginning of your venture.  You look at your spouse and smile, this is home.  ”I’ll take it!” you say with pride.  Your spouse shoves their elbow in your side and gives you a dirty look, “I mean… we’ll take it!”

The Realtor takes care of the negotiations for you and a price is settled.  How do you pay for it?  You get a mortgage.  Your Realtor recommended a great mortgage broker, that’s an independent seller that can give you prices on many mortgages from lots of banks.  They offer a wholesale price, and get a kick back from whatever company you decide on.  Instead you decided to go talk to your banker at the local Wells Fargo.  Since you already have your accounts with them, you’d like everything grouped together.  You aren’t the type to take risks, and this is your home, so you get a 30 year fixed rate mortgage and put 20% down.

Every month for the next 30 years you expect to get a bill from Wells Fargo.  That sounds perfectly reasonable.  Well after a year or so you receive a notice from your bank that your mortgage has been transferred to another institution.  Your bills will now come from JP Morgan Chase.  What happened?

JP Morgan bought you mortgage.  If I loaned you $100 at 10% interest and tell you it must be payed back in one year, I might decide I want my money now.  I could sell the rights of the loan to someone else for something like $102 and move on.  That’s what Wells Fargo did.  Its a standard practice now, and that is the purpose of Fannie Mae and Freddie Mac.  They’ll buy it from Wells Fargo, package the mortgage in with other loans and sell it off to another institution like a bank, hedge fund, pension, or a foreign company.  The packaged mortgages are sold as “mortgage backed securities”.  You buy the security which gives your ownership rights to the mortgage.

Why is this done?  Because there is demand for it.  Banks want to account for the revenue now by selling the loan, and the buyers are interested in holding the loans long term.  This means they’re willing to take their profits later.  The selling of mortgage backed securities also allows banks to get the loans off of their books, which lets them go sell more loans.

The bank gets a small profit from the sale plus any origination fees, Fannie and Freddie take a cut when they re-sell, and the end user of course gets the interest on the loan.  Everyone is actually happy with this type of transaction, except the end used.

Now you have JP Morgan sending you bills and your data sits with them.  That means direct mail for home equity loans and credit cards (i.e. Spam).  Worse, if you have a question you can’t go down to the local branch, because there aren’t any in your area.  This is what happened to my parents.  They’ve had the same bank for decades and got their mortgage from them.  The bank sold their mortgage to Wells Fargo, which has exactly no branches within a 2 hour drive of their house.  Let’s wait and see if this strategy is still working in 5 years…

categories: banking, business, college of weakonomics, economics, government, loans