Last week the Wall Street Journal ran an article with the following two-part title: The Mortgage Market Never Got Fixed After 2008. Now It’s Breaking Again.

Predictions aside, there is no doubt that the Journal got the first part exactly right. 

Prior to the 2008 meltdown, every aspect of the mortgage business—from banks, to nonbanks, to appraisers—was highly regulated. And the mortgage lending business was heavily tied to the Federal Housing Administration (FHA) and to Fannie Mae and Freddie Mac (both ultimately backed by the federal government). 

Twelve years after the crash, none of that has changed. 

If anything, the situation is even worse. The market is more dependent on government-backed loans than before, and Fannie and Freddie remain in government conservatorship with a razor thin capital cushion. Although the average credit score is now a bit higher than it was leading into the crisis, the market is as flush as ever with the same kinds of risky, high debt-to-income and low down-payment loans that contributed to the crash. 

The 2010 Dodd-Frank Act thrust even more regulation—much of it more prescriptive than previously—on the financial industry, and essentially forced many banks out of the home loan business. The False Claims Act fiasco with the FHA also resulted in fewer banks originating FHA loans, and ongoing regulatory pressure has been pushing banks out of the mortgage-servicing business. 

This part of the industry, the mortgage servicing business, is what the second part of the Journal article’s title is referring to as “breaking.”

The servicing sector consists of companies that collect homeowners’ mortgage payments and pass them on to someone else, most frequently the FHA, Fannie Mae, or Freddie Mac. These three entities, in turn, pass those payments on to the people holding mortgage backed securities (MBS).

In general, when a mortgage holder is late with his payments, the servicer is still responsible for passing those funds on. The details vary depending on to whom those payments are getting passed, but the general idea is the same. Of course, there are limits to these contractual obligations. 

In the case of Fannie and Freddie, for instance, after 120 days the servicer typically no longer has to provide payments. (Fannie and Freddie also have some contracts with servicers that do not require any funds to be passed on unless the servicer receives the scheduled payment from the homeowner.) If that loan is later foreclosed, the servicer is reimbursed for the funds that it advanced on the delinquent loan before the 120 day mark.

Banks used to be more involved in mortgage servicing. Now, however, non-bank financial firms are handling a larger share of the mortgage servicing business than prior to the 2008 crisis. This fact alone does not present any particular problem. 

But, now that Congress has essentially told homeowners that they have the right to stop paying their mortgages for at least 180 days (see Section 4022 of the CARES Act) due to any hardships from the COVID-19 pandemic, the servicers are in the spotlight. 

According to the AEI Housing Center, more than 4 million loans are now in forbearance. Fannie and Freddie account for 44 percent of those loans, and Ginnie Mae (the securitizer of FHA loans) accounts for another 29 percent. (Other estimates are similar.)

Clearly, the servicers are going to have to cover the mortgage payments for a large chunk of borrowers. It remains difficult to estimate precisely how much, but the total amount that they will have to pass through without being paid by the borrowers could range from several billion to as much as $100 billion. (The latter figure was cited by a bipartisan group of senators; Cato’s Diego Zuluaga has projected a figure closer to $10 billion.)

Some suggest that this wouldn’t really be a problem if banks were still doing the bulk of the mortgage servicing. They have more funds available than non-banks and also can borrow from the Federal Reserve (either through traditional means or one of the new lending facilities that the Fed is creating to deal with the COVID-19 crisis). 

But that’s a hypothetical. The reality is this: servicers are stuck in the middle, and they do not have unlimited funds. The key to solving this problem is to recognize exactly where the servicers are stuck.

The mortgage holders, whom Congress has told to stop paying their mortgages, are on one side. On the other side, for roughly two-thirds of the mortgages, is a government-backed entity that, thanks to Congress and the U.S. Treasury, has promised investors that they will be paid in full. 

In other words, Congress created this mess. 

And the real core of the problem is not the COVID-19 pandemic; it is the fact that Congress put federal taxpayers on the hook for these mortgage payments no matter what. 

It is true that Ginnie Mae recently announced a lending facility for servicers to provide liquidity. And the FHFA recently announced it will allow Fannie and Freddie to purchase mortgages in forbearance, thus relieving some liquidity pressure from servicers. 

But these measures—just like a Federal Reserve lending facility for servicers—amount to nothing more than passing the buck on to someone else. 

Congress created a system that fleeces federal taxpayers when people stop paying their mortgages. Now that the consequences from this system are being felt, Congress has to deal with it.