Risk Shadow Banking Poses To Housing

Q: Do you think the bank failures that happened earlier this year will affect housing? Rajiv, Edison, NJ

A: The largely non-regulated non-bank financial system now controls almost half of the world’s financial assets fueled by years of very low interest rates. Shadow banking was at the center of the global financial crisis when questionable mortgages were transformed and weaponized as complex securities that were resold and ultimately helped bring the global financial system to its knees. Non-bank financial institutions are big and highly leveraged right now. We now live in an interdependent world, so a liquidity crisis in one part of the financial system will always have repercussions in other parts as was the case during the global financial crisis.

The mortgage market is much different now than it was before the global financial crisis with non-bank lenders accounting for ⅔ of all new mortgage originations. Despite the fact that mortgage underwriting is much more thorough and robust now than it was before the financial crisis, non-bank lenders generally lack the capital required to absorb a liquidity crisis caused by an unexpected event. A big rise in mortgage defaults could be catastrophic to non-bank lenders if the short term warehouse lines of credit they rely on dry up in a liquidity crisis, which in turn would make it much more difficult and expensive for home buyers to get mortgage financing. Thanks for your question, Rajiv.

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