It's a liquidity issue.

Mortgage and Lending with Umpqua Bank

With all of the changes in the Mortgage industry in the last three weeks it may seem that we need to run for cover.  Well, it's not, "1980 all over again."  There will be some major bumps along the road, but at least the interest rates are not driving the problem.  The driver is the lack of liquidity.

Imagine that you are a lender and someone gives you a "portfolio bucket."  Let's say that your bucket can hold $100mm in loans.  You set the interest rate and tell your staff to go out and make loans.  Before too long, your bucket is half full.  This doesn't worry you as you've been making money the way that lenders do, through interest rate margin (the difference between your cost of funds and what you are charging for your loans) and loan fees.  Life is good.  You're on top of the world and quite profitable.

Suddenly, your bucket fills up with all of the loans you told your staff to bring in.  While you still have interest margin gain, you no longer can make new loans.  Thus, you have lost the ability to generate fee income.  There are only two options available; 1) leave the bucket full, watch your income decline, and lay-off your staff; or 2) empty the bucket and start making loans again.

"Emptying the bucket" is a way to describe the sale of the loans on the Secondary Mortgage Market.  Currently, the problem in the Alt-A and Sub-prime markets is that there is nowhere to empty those buckets.  There is no one stepping up to buy those loans.  As a result, there is no "liquidity" being injected back into those markets.  With no place to sell those loans lenders have to stop making them.  It's a liquidity issue, plain and simple.

The next blog will describe what the "eye of the storm" looks like, when we get there.  (We're not there yet.)

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