Back to reality

When we began preparations for the launch of Mortgage Risk earlier this year, the US subprime troubles were just that: US troubles, certainly not the nexus of a global crisis.

In the months since, the view that contagion to European markets couldn't happen became an assertion that it shouldn't. The credit story turned into a liquidity story, and the mortgage industry got an unwelcome reminder of how capital markets affect the day-to-day business of mortgage lending.

All this makes now an ideal time to launch the magazine. Mortgage Risk is devoted to covering the financing and risk management of the mortgage business from the capital markets to high-street lending.

At the time of going to press, the fifth-biggest lender in the UK (Northern Rock) is front page news, with investors queuing outside its doors to withdraw deposits. The lender sought emergency funding from the Bank of England after finding itself unable to raise funds in current markets.

In the US, Countrywide has seen its shares dip more than 50% this year and at times the lender's solvency has looked under threat. Both have been victims of their exposure to the capital markets rather than bad lending.

And while market participants have been hopeful about markets returning to normal this year, some say this could be a sea-change that will not reverse quickly.

One concern is that the structured investment vehicles (SIVs) and conduits that have been an increasingly important part of the investor base for mortgage securities might prove unsustainable in their current form.

Money-market investors who provide rolling short-term funds for these vehicles are not always inclined to spend time analysing complex assets. Lending to SIVs was fine when the triple-A ratings on collateral could be trusted. Now that ratings seem open to surprise revision, those investors might exit the market not to return.

The effect of this could be a permanent realignment of funding costs for mortgage lenders. SIVs and conduits manage their cost of financing by relying heavily on cheap commercial paper. Real-money investors find it harder to buy long-term assets and fund themselves with short-term liabilities due to their more stringent liquidity ratios.

Thus, as the residential mortgage-backed securities market reacquaints itself with real-money buyers, it could find those buyers demand better spreads. This will initially reflect the new power in the hands of investors since those are in short supply. But the change could prove durable. Already, lenders in the UK are increasing rates, showing they are preparing for a longer period of increased funding costs and possibly a long-term change. Investment banks, meanwhile, are busy trying to map where the real money needed to sustain the mortgage markets is to be found.

- Rob Mannix, Editor.