Here We Go Again: The Goosing Of The Mortgage Market

Includes: JPM, WFC
by: John M. Mason

"Wells Fargo (NYSE:WFC) Posts Record Profit as Mortgage Banking Arises."

"JPMorgan (NYSE:JPM) Profit Beats Estimates as Mortgage Revenue Soars."

The third quarter bank earnings are being announced. And, the hero is ... the mortgage market!

At Wells Fargo, third-quarter profit increased by 22 percent as Wells posted a record amount of earnings.

At JPMorgan profit rose by 34 percent.

The mortgage market is booming and Wells Fargo and JPMorgan are taking advantage of it as the two largest originators of residential mortgages in the United States.

In the first half of this year alone, Wells Fargo is estimated to have originated one-third of all the mortgages made.

Note that these loans, according to Bloomberg, were made at "the cheapest interest rates in history."

As a consequence, the net interest margins earned by both these banks fell.

However, in terms of earnings this didn't hurt these banks much because the banks don't hold onto the mortgages for long…they package them and sell them. So the earnings they receive come from the fees earned from originations and from servicing.

Bloomberg reported that Wells Fargo earned about one-quarter of all its fees from mortgage originations and servicing.

The results are not surprising because mortgage loans at commercial banks have shown a substantial increase in the past quarter. As I reported in my recent review of the banking statistics:

"Residential real estate loans, i.e., mortgages, have also been increasing in recent months. Much of the increase has come in the last six weeks or so, with $14 billion of the increase coming in the past four weeks. The interesting thing about the rise in mortgage lending is that a large part of the increase -- almost 90 percent -- has come from the largest 25 banks in the county.

Again, this is good news, for this pickup had to come if any increase in the housing sector was going to take place."

This euphoria is spilling over into a dream that there will be "A New Housing Boom." This from Roger Altman, founder and chairman of Evercore Partners, and Democratic insider and power broker.

What seems to be behind this movement? The Federal Reserve, of course.

And, we have just seen the beginning of this. In the Financial Times Friday morning we read the headlines: "Fed's Bond Buying Set to Send US Mortgage Rates Even Lower." This is based on the fact that the new quantitative easing program of the Fed envisions substantial new purchases of mortgage-backed securities every month for the foreseeable future.

The psychology in the "large" commercial banks has changed and the psychology in the MBS market has changed.

The Fed's third "throw the spaghetti against the wall and see what sticks" effort seems to be having some impact.

And, who is benefiting?

Well, the large banks. And, homeowners whose home values are not underwater because much of the mortgage lending taking place is in the form of re-financings. These are generally wealthier homeowners.

And, of course, hedge funds. See, for example, "Hedge Funds Reap Gains from MBS" and "Funds Enjoy Fed Boost for Bundled Debt Deals." In this latter article we read, "One hedge fund strategy has stood out for its performance ahead of all others this year: 'structured credit.'"

Well, so much for the little guy.

The question that still remains concerns the rejuvenation of the housing market: "Will home building be stimulated sufficiently to return housing construction to more normal levels?"

The concern is that all these funds will go directly into asset prices without providing much stimulus to building houses and putting people back to work again.

This is part of what Mohamed El-Erian has been arguing about the current Federal Reserve quantitative easing. In a recent Financial Times article El-Erian argues that "Investors must pay attention to western central banks and respect the market influence of unconventional policies but they should do so with a wary eye on how far, and for how long, valuations can be divorced from fundamentals."

Here is the situation as I see it. The Federal Reserve is desperate to get some real economic results and as a consequence is throwing about all the "stuff" it can against the wall to get something going.

This action will have an impact on markets. Right now, the impact is creating a "bubble" as El-Erian describes it. There are opportunities to make money…and lots of it…due to these "unconventional policies."

How much this "bubble" affects the real production of houses and the employment of labor remains to be seen. According to El-Erian, it depends upon "how far, and for how long, valuations can be divorced from fundamentals."

And, who is immediately benefiting from the Fed's efforts…large banks, wealthy homeowners, and hedge funds.

But, this is almost always the case, as the past fifty years of credit inflation created by the US government shows. No wonder the income/wealth distribution gets more and more skewed toward the wealthy.

I hope you can take advantage of this opportunity.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.