This is generally a pretty interesting article, but I wish he'd expand into the other risks inherent to pools of mortgages:

1) Default risk - Obviously if I invest in pools of mortgages, and a lot of people stop paying their loans, I am exposed to risk. In many cases I'm insulated, because if someone defaults, I now own the home and can sell it to recoup my losses. But there's costs associated with foreclosing and in some cases, the value of the house goes down by enough that I can't recoup my money anyways (see 2008). We slice and dice mortgage pools to reflect this, so that the junk bonds are at the bottom and pay more and the AAA are at the top and don't lose anything until the lower tranches lose everything.

2) Interest rates rising - he discusses this in the article. If interest rates go up from 5 to 10% then any notes I held on a 5% loan are worth less.

3) Interest rates falling - this is called "pre-payment" risk and is what makes mortgages so interesting (and much harder to value than corporate bonds and most other loans). See point 2 for why rates rising hurts the owners of mortgage notes. You might think that rates falling would therefore help them, but it doesn't directly correlate. If rates fall enough, many people will refinance their loans. You have the right to pay off your mortgage at any time and another bank will be happy to step in and give you a new loan. So if rates fall from 4% to 2%, you can bet that most people will refinance. If I'm an investor holding a pool of 4% loans, then most of those loans will get paid off and now I'm stuck being in a market where I can only buy pools of 2% loans. Corporate bonds generally don't work this way. Auto loans technically do, but given the size and durations of the loans, it's usually not worth the hassle to refinance in the way it is for a house. This pre-payment risk makes the modeling of mortgage investment much more complicated, but also more interesting than many other financial securities.

Ironically it doesn't mention the elephant in the room. US Fed is now funding T2.6$ worth of mortgages [1]. US Fed began purchasing RMBS assets (essentially mortgages) in order to support the housing market as one of its responses to 2008 crisis [2]. It was meant to be a stop-gap measure, but it hasn't ended.

BTW this is a good overview of different parties involved in the mortgage supply-chain https://imgur.com/NYg7G4t

[1] https://fred.stlouisfed.org/series/WSHOMCB

[2] https://www.newyorkfed.org/markets/mbs_faq.html

If government banned long term debt would the real estate market disappear, or would home and auto prices eventually level out at a much smaller amount reducing overall inflation, or would ownership just be for the wealthy and the rest would live in pottersville?
The entire financial system in the U.S. is a manufactured product, if you really think about it. The USD has intrinsic value even if Americans don't lift a finger since you need US$ to purchase most goods on the commodities market.

If this link is broken, the U.S. would almost immediately fall into decline. The net spending power of most Americans would drop by a third to one half of what it is today, leading to social unrest. The U.S. government wouldn't be able to fund many of its programs, such as Medicare and the DoD would need to drastically cut its budget.

So what is better?

Mortgages seem to have some pretty nice features. They help encourage people to invest some of their income into an asset that generally appreciates rather than spend it all. It aligns incentives around upkeep and investment in the neighborhood and community. They offset some of the negatives of inflation.

If you want to learn more about mortgages and the "behind the scenes" slicing, dicing and preparing, please check out "The Compleat Ubernerd": https://www.calculatedriskblog.com/2007/07/compleat-ubernerd...

It's a series of posts from a lifelong banker about all of these details, from the 2007 timeframe. Super interesting deep dive.

The worst part of this whole system is the complete opacity about what company will actually service the mortgage after you finish signing. As it turns out, some companies provide a much better and more modern servicing experience than others (for example: Chase versus anything Cenlar).
>educate them on the most complicated and high-stakes financial decision they’ll have to make in their lives,

I disagree with this hyperbole (part of the overall tone of the article). I think taking on full-time college tuition at age 19, or having kids, are both far more complicated and consequential financial decisions.

Taking out a mortgage to purchase, let alone re-finance, an owner-occupied residence is something a lot of people do, perhaps more often than they buy a new mattress. If you have the minimum down payment and good income & credit report, it's not a big deal, and since there are a lot of legal protections all around for owner-occupied properties, it's straight-forward and low risk to the one taking out the mortgage.

Is Stripe going to revolutionize the financing of residential homes? :)
I'm confused about this part:

>A mortgage has a quirky little subcomponent called a Mortgage Servicing Right (MSR). Every month, it needs to collect money from the borrower and send that money… somewhere. This implies, minimally, a mailbox where you can send checks, someone to open the mail, and a phone number with a CS representative who can answer questions like “What is my current balance?” and “Did you get the last check I sent you?”

I thought mortgage payments were mostly done electronically now?

Mortgage brokers make crazy money in the U.S. Generally around 2% of the loan amount so they're making $6,000 on a $300,000 loan.

At the particular mortgage broker that I have inside knowledge of, their worst loan officers are closing 5 loans per month and their best are closing 30 or more which gives them an annual salary of between $400,000 to over $2 million.

This is more of a tangential comment, but I absolutely love patio11's blog. As someone who is generally interested in fintech and financial services but does not have the time to read deeply into it, this blog is a treasure mine.
I wonder why fixed interest rates are so prevalent in some countries (like, apparently, the US) while in other countries the standard is to tie the interest rate to a reference rate (like EURIBOR in the Eurozone)?
Here in the UK, as far as I can tell, your lender can't sell on your mortgage. It's a contract between you and them. I wonder how many countries do allow that.
I wish we had 30 year fixed-rate mortgages in Aus
Slightly off topic: What should I read if this is all super interesting but Byrne Hobart is a smidge over my head?
> Private capital buys all the other risks.

What about the Fed? It is not private capital.

There's a lot to add to this article in my opinion:

Many lenders refinance loans because lenders also need to finance their activities and refinancing through securitization is a profitable way to do so, that goes for student loans, business loans, private loans, car loans, ...

Mortgages are no exception, what is different about the US compared to Europe is that the capital market to buy packages of loans is more developed because unlike the EU, the US is a unified financial and legal system under federal governance.

What happens in a mortgage is not that much different than a car loan, you use some cash and borrowed money to pay for the car and the lender expects you to repay that money (and interest) in fixed installments. Should you fail to pay the loan then the car is repossessed. The lender will want to make sure that your monthly salary is enough to cover the payments and that the car is valuable enough to recover the principle of the loan should something happen.

Incidentally, this is why banks don't like to give entrepreneurs mortgages because entrepreneurs don't have stable income (usually).

The moment you borrow that money, it becomes a liability for you but it becomes an asset for the bank/originator; after all you are going to pay the originator cash for 25 years.

Now in the US, your originator can sell this asset onwards to a loan aggregator (Fannie Mae; Freddie Mac) to realize profits today rather than hold the mortgage forever but obviously the loan aggregator has some standards it wants you to adhere too. (note: the EU doesn't have these types of loan aggregators due to the lack of synchronization between their national financial markets)

In theory the originator can make more profit by holding the mortgage, but since his money is locked up for 30 years in the mortgage; many of them don't have enough cash on hand to just lend the money and wait 30 years for it to come back so it can be lended out again.

The loan aggregators on the other hand buy mortgages from all originators and can put them together into a package that is safe and diversified enough so that the repayment performance is predictable enough (ignoring pre-2007 when rating agencies succumbed to customers' pressure to rate pretty much anything as safe and caused the huge financial meltdown when borrowers started to predictably default) and sell it onward to pension and sovereign wealth funds.

These aggregators, or GSEs as patio11 calls them, are private companies but by now they are government owned because they all collapsed in the financial crisis and since they underwrite pretty much every mortgage in the US, they had to be saved as otherwise the mortgage originators would also become illiquid and then you can only buy a house in cash (which would have pretty much destroyed the entire housing market in 2008).

The 60 basispoints though, is the fee for packaging the loans. It's not an insurance like patio11 says.

Operational work like support, collections, negotiations about late payment and administrative work ("Servicing") is outsourced is just because no loan aggregator wants to deal with that and a pension fund DEFINITELY doesn't want to deal with that and like any outsourced service that is well-understood, they prefer to pay as little as possible for this part. This creates natural market pressure for consolidation.

2008 calls, if you didn't know this already I guess this is a good re-hash.
It has always annoyed me that the financial services industry attempts to referred to mortgages, loans and other financial instruments as "products". By definition, they are services. The many papers you get when signing a mortgage is about the closest thing you could refer to as a "product". I think they do this to attempt to create a sense of finality and inflexibility in what they are selling. "It's a product" makes it seem like a fixed thing that cannot be changed, when in fact, it definitely can be.