The Canaries in the Coal Mines Are No Longer Singing
The Federal Reserve has declared its program of monetary expansion (formerly referred to as inflation) over in an effort to fight rising prices (currently referred to as inflation). As Murray Rothbard explained, "Government intervention brings about bank expansion and inflation, and, when the inflation comes to an end, the subsequent depression adjustment comes into play."
Adjustment in the mortgage world has come quickly, as one might expect with a near doubling of the home mortgage rate since the first of the year. On July 7, non-QM (qualified mortgage) lender, Sprout Mortgage suddenly closed its doors without notice, a day before payday. HousingWire reported, "A of Friday [July 8] around 1 p.m. Sprout failed to pay their last paychecks." Writes Flávia Furlan Nunes:
Sprout is the second major non-QM lender to shut down operations recently. First Guaranty Mortgage Corp. (FGMC) and its affiliate Maverick II Holdings filed for Chapter 11 bankruptcy protection in late June after suddenly cutting hundreds of jobs.
Of course, up until the explosion in home loan rates, the mortgage business was on fire as people bought new homes or refinanced their current loans. Employees told the press Sprout was doing $350 million in loans per month, with plenty of deals in the pipeline that it's doubtful will be funded. "At least one employee even has their own personal mortgage in the Sprout pipeline and has not received an update on the loan's status, former workers told HousingWire."
One Sprout executive was bullish on his company's prospects, telling National Mortgage Professional, "The average loan amount was $700,000 and the average FICO score was 720," the executive said. "These were not risky loans. There was no shady stuff in these loans."
The executive continued, "Non-QM is a $100 billion industry. It was an opportunity for Sprout to be the No. 1 [non-QM] lender in the country."
The executive added:
We were good at closing loans; average was 15 to 22 days, and things were funding quickly. The faucet just got turned off.
How does a business doing $350 million in funding a month suddenly hit the wall?
One former capital markets staffer, who requested anonymity, said Sprout had been dealing with liquidity and funding problems for months. Unlike some of its peers, Sprout wasn't backed by a major asset management firm, and it was particularly vulnerable to a lack of liquidity from investors. It couldn't handle the widening spreads and began taking losses on loans originated in the beginning of the year.
Mortgages are like bonds; when interest rates rise, the value of the principal balance falls. In other words, investors will pay less for a given stream of income, or in this case, a borrower's payment. In December 2021, thirty-year mortgage rates were just over 3 percent. On July 7, the average was 5.3 percent, according to the St. Louis Fed. Any mortgages that were made last year or early this year and hadn't been sold are worth a third less with current rates.
"They're not going to be able to make much money selling these loans," one industry capital markets veteran who did not work at Sprout told HousingWire. "They can hold it and wait for the market to recover. And warehouses are probably making a margin call based on the mark down of those loans."
Meanwhile, large realtors Redfin Corp. and Compass Inc. laid off 470 and 450 employees, respectively, the Wall Street Journal reports. "With May demand 17% below expectations, we don't have enough work for our agents and support staff," Redfin chief executive Glenn Kelman said in a blog post. "We could be facing years, not months, of fewer home sales."
During some months in 2020 and 2021, with low mortgage rates and housing demand so strong, Redfin added as many as a thousand agents. Labor, just like capital, is misappropriated in a boom. In 2020 and 2021, "more than 156,000 people became real estate agents [nationwide]—about 60% more than the previous two years," Kate Talerico wrote for Mansion Global:
"In a bull market, you just get bloated generally," Eric Sussman, managing partner of the California-based real estate investment firm Clear Capital Inc., said. "In the real estate business, brokers are fairly easy to add. You provide some nominal amount of overhead, basic training and then let them go out and eat what they kill, so to speak."
Now real estate companies are hitting the brakes. Rothbard explained in Libertarian Forum:
The government-induced inflationary boom not only injures consumers by raising prices and the cost of living, but also distorts production, and creates unsound investments. The government is then faced repeatedly with two basic choices: either stop its monetary and bank credit inflation, which then will necessarily be followed by a recession which serves to liquidate the unsound investments and return to a genuinely free-market structure of investment and production; or continue inflating until a runaway inflation totally destroys the currency and brings about social and economic chaos.
The Fed's Jerome Powell has also opted to hit the brakes, making the Sprouts and Redfins of the world canaries in the coal mine.