The expanding presence of mortgage companies has brought benefits to consumers and the economy. Among the benefits are increased competition and technological innovation. Mortgage companies are generally able to react more nimbly to changes in market conditions and have been faster to deploy new technologies such as online mortgage origination platforms. But the rising market share of mortgage companies has also brought with it increased risks. I will focus here on the risks most relevant to financial stability.

One major vulnerability of mortgage companies is liquidity—that is, their ability to finance their portfolios of assets.3 Unlike banks, mortgage companies typically do not have access to liquidity from the Federal Home Loan Banks or the Federal Reserve System. Mortgage companies also do not have access to deposits as a stable funding source. So while banks will hold some originations on their balance sheets, mortgage companies first fund their originations on warehouse lines of credit that are usually supplied by banks. Typically, after a couple of weeks, the mortgage company repays the warehouse line and securitizes the mortgages. During the last financial crisis, when the private-label mortgage securitization market started to freeze, mortgage lenders could not transition their originations from the warehouse lines to securitization. Warehouse lenders became concerned about their exposures to the nonbank companies and cut off their access to credit. As a result of this funding crunch and other factors, many lenders failed, including household names like New Century Financial Corporation.

The risk of events like this one repeating is probably more limited today because mortgage companies primarily originate mortgages that are securitized through the far more stable GSE or Ginnie Mae markets. Instead, the main liquidity concern today comes from mortgage servicing. If borrowers do not make their mortgage payments, mortgage servicers are required to advance payments on the borrowers' behalf to investors, tax authorities, and insurers. Although servicers are ultimately repaid most of these advances, they need to finance them in the interim. The servicers' exposure is greatest for loans securitized through Ginnie Mae, as they require servicers to advance payments for a longer period than the GSEs. In some cases, servicers may also have to bear large credit losses or pay significant costs out of pocket. Because mortgage companies are now the major servicers for Ginnie Mae, this liquidity risk—and possibly solvency risk—is a significant vulnerability for these firms if borrowers stop making their payments.

If these firms collapse, what are the repercussions? Clearly, there is considerable potential for harm to consumers, and that harm would likely be concentrated in communities that are traditionally underserved. In recent years, mortgage companies originated the majority of the mortgages obtained by Black and Hispanic borrowers as well as the majority of mortgages to borrowers living in low- or moderate-income areas.

What does this have to do with financial stability? One aspect of financial stability is the amplification of shocks—in other words, how a problem initially confined to one part of the financial system can spread to involve broader swaths of borrowers and investors. During the housing crisis, the fragility of mortgage companies was an important source of this kind of amplification. In particular, rising mortgage defaults led to the collapse of many mortgage companies, which in turn was one of the key drivers of a significant pullback in the supply of mortgage credit. That tightening in credit then weighed on house prices, as potential homebuyers, who once would have been able to get a loan, found mortgages expensive or impossible to obtain. As a result, even families who had not been involved in the mortgage frenzy of the mid-2000s found the prices of their homes falling sharply. Today's housing market is much more robust, and the risk of a financial crisis originating from this sector is currently low. Nonetheless, if some large mortgage companies fail and other firms do not step in to take their place, we could see adverse effects on credit availability.

Policy Responses to the COVID-19 Crisis
Against this backdrop, the massive economic shock triggered by the COVID-19 pandemic broadly tested the resilience of our financial system. As the pandemic unfolded, strains occurred across financial markets as investors dashed for cash amid widespread lockdowns and fears about the economic and financial outlook. Mortgage markets, in particular, began to show significant signs of stress. The MBS market, like those for other fixed-income securities, became extremely volatile, and with the unemployment rate spiking, market participants worried that borrowers would be unable to make their mortgage payments.

The Federal Reserve's response to the crisis, which was prompt and forceful, included moving the policy interest rate to the effective lower bound, conducting large-scale purchases of Treasury securities and agency MBS, and implementing a number of emergency lending facilities to support the continued flow of credit to families, businesses, nonprofits, and state and local governments.

On the fiscal policy front, the CARES Act (Coronavirus Aid, Relief, and Economic Security Act) provided economic stimulus checks and enhanced unemployment benefits to individuals as well as eviction moratoriums for renters and a requirement that mortgage servicers grant borrowers up to 12 months of forbearance. All of these policy responses were crucial in easing the stresses in financial markets and helping us weather the period when much of the economy was shuttered.

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