Worldly Wise: Big gains for the bailout barons

The US mortgage business has become fantastically profitable, as banks, many backed by a too-big-to-fail guarantee, charge home borrowers fat fees for the low risk business of originating loans and selling them on to — you guessed it — the government.

While the bank bailout was touted as injecting public money into the banks so that they could start to lend again, the evidence paints a depressing picture. Actual lending is down at many of the largest banks, while profits from trading have ballooned.

Meanwhile the fees that banks charge to originate mortgages — the vast majority of which are now sold on to quasi-government institutions Fannie Mae and Freddie Mac — have risen sharply, leading to much higher profits for the banks in a very low-risk business.

Wells Fargo reported $1.1 billion (Dh4 billion) of revenue from loan originations and sales earned from total residential loan originations of $96 billion. That revenue figure is more than four times what the bank earned in the same period a year ago.

Charges and fees on loans were $453 million, up 70 per cent from last year and up 12 per cent from the second quarter. Similarly, US Bancorp recorded a $215 million increase in the quarter in mortgage banking revenue compared to a year ago.

Now of course some of this is simply that low interest rates are driving volumes in refinancing. It would be churlish to argue that banks shouldn't get their share for originating the loan, right? Not exactly.

A recent study by the Mortgage Bankers Association showed that the industry was making a profit of over $1,088 per loan in the first quarter of 2009, as against just $148 in the last quarter of 2008.

Industry publication Inside Mortgage Finance reported that the nine largest lenders, about two thirds of the industry, made $9.1 billion in the first six months of this year, putting them on track to earn five to six times the amount they did in 2008.

Remember, these are mostly origination fees rather than any kind of payment for the higher risk of holding the loans.

It would be reasonable, given the terrible performance of housing as an asset and the very high unemployment rate, for mortgage rates to have risen to compensate investors. But that is not what these fees represent.

Four out of five loans being made are going through government-sponsored mortgage giants Fannie Mae and Freddie Mac, and the Federal Reserve has been buying up these loans right and left in order to artificially make the interest rate lower.

Protection and profits

Profits were certainly suppressed in 2008 by low volumes and by some risky loans being forced back to the originators, but it seems clear that the business of originating mortgages has suddenly become quite profitable.

So, is this a problem and, if so, will it be sustained?

Higher fees impose a cost on borrowers. This blunts the impact of lower interest rates and, on the margins, makes housing less affordable. If the effect of Federal Reserve purchases of mortgages has been to make rates 50 basis points lower than they otherwise would be and the average $200,000 mortgage includes an additional $800 in profits for the originator, much of that impact of lower rates is going into banks' profits rather than to consumers.

It is impossible to say that this is a direct result of the bank bailout but policy seems likely to have played a role. Many competitors in the mortgage market from a year ago are now gone, and consolidation has made the big even bigger.

And while some banks can boast of having repaid their government money, the too big to fail will not be allowed to fall. Size and government-guaranteed safety is a tough combination to compete against.

High profits should attract new entrants eager to take some of the business, but really, if I was going to start a business I might think twice about competing against someone with size, scale and funding costs that reflect an implied government guarantee.

That is a tax on the rest of the economy, imposed by the government for the benefit of certain parts of the financial system.

The banking rescue was sold on the basis that the economy would end if banks did not get aid. It succeeded in saving the banks and probably too in avoiding an economic meltdown.

It also helped to foster a financial sector that lends less, makes more from speculation and charges higher fees for utility tasks like loan origination. How many votes, I wonder, would that proposition have gotten in Congress?