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Mortgages, in theory, part 3 of N
blaisepascal
So we've covered what happens in a straight-forward mortgage situation, under both repayment and default/foreclosure situations. Now let's make it less straight-forward.

Complication 1: mortgage notes as negotiable instruments.

In our sample problem, Harriette bought a $125K house, borrowing $100K from Bob to do so, at 6% amortized over 30 years. To Bob, what he sees is an income stream of $600/month for 360 months, or a total of nearly $219K over the 30 years. Inflation, risk, and the so-called "time value of money" make the income stream have a present value much less than $219K, it's still worth more than $100K to Bob. Which only makes sense: Bob is in the business of lending money for profit; if the projected income stream from the loan (taking into account inflation, risk, and time) wasn't worth more than $100K, he wouldn't lend the money.

However, it's still the case that one day Bob had $100K, and the next Bob has a secured promissory note from Henriette. He (or rather, the bank he works for) can't spend that promissory note on salaries or bank interest to depositors; can't give it to the Federal Reserve to meet banking deposit regulations, and can't loan it to other people. It's a money-making asset, but it's not money, and sometimes what a bank needs is money.

What Bob can do, however, is sell the promissory note he got from Henriette to another party. He can contact Bill, at another bank, and offer him the note in exchange for cash. Assuming they agree to a reasonable price (say, $120k), Bob simply writes "Payable to Bill, no recourse, signed Bob" on the bottom of the note, and now Bill gets the income stream. Depending on how Bill and Bob choose to handle it, Bob could still collect the payments from Harriette and pass them on to Bill, or Bill can contact Harriette and ask to be paid directly.

Of course, Bill can then sell the note to Bruce, who can sell it to Bryan, who sells it to, well you get the idea. When a lot of transfers happen (and they can, considering bank mergers, sales, and other forms of just doing business), it can get tricky for the homeowner to keep track of where she is supposed to send the check. That's where Sam comes in. Sam is a servicer, and his job is to act as a middle-man between Harriette and Bob, Bill, Bruce, and Bryan. Harriette sends her monthly payment to Sam, who pools it with a lot of other mortgages he's servicing, and sends big checks to Bruce, Bryan, Bill, etc. If Bryan sells Harriette's note to Bernard, they tell Sam, and Sam then sends Harriette's money to Bernard, not Bryan, and Harriette's none the wiser. Sam also handles assessing late fees, dealing with home-owner issues, etc.

Complication 2: Mike the Mortgage Broker.

Bob's normal business is borrow money from depositors for one interest rate and lend it out to borrowers at a higher interest rate. Banking used to be jokingly described as a "3-6-3" business: pay depositors 3%, charge borrowers 6%, and be on the golf course by 3pm. Life has gotten harder for bankers since that joke was current, but banks still typically hold on to a lot of loans as bank assets and collect payment on them. They can, if need be, sell Harriette's loan, but there's also a good chance they'll hold on to it. He's into the mortgages for the long haul -- besides, he's got lots of investment options; he can make lots of types of loans, he can buy treasury bonds, etc.

Not so with Mike. Mike's business runs a different way: make loans and sell them off as fast as possible. If Harriette had gone to Mike instead of Bob, Mike would have lent her the $100K and immediately sold the note for $120k, pocketed $20k and lent the $100k out again to Hank, sold that note for $120k, pocketed another $20k, and then do it again, and again, and again. Needless to say, Mike likes Sam, since Sam means that Mike never has to deal with Harriette again after lending her the money.

What makes this even more amazing for Mike is that he doesn't even need to start with $100K. He can even borrow it from Bob (or, more likely, from Ivan, Inga, Isaac, and other investors), and as long as he has the cash on hand to make his interest payments, he can just keep pulling in money as long as he keeps selling mortgages.

It's possible to run a Mortgage Originating company with very thin margins: Let's say Mike's Mortgage Company has $1M in assets to lend out, which it borrowed at 3% from Isaac and Iris. Every month, Mike needs to make a $2500 interest payment to Isaac and Iris and $2500 in rent and utilities for his office. If he can manage to loan 10 homeowners $100k and sell the resulting notes for $120k each, he can pay the investors their $2500, the landlord and utilities their $2500, and issue himself a bonus of $150k and still technically show a profit of $45k that month. But if he can't get those 10 loans made and sold, he could be seriously screwed, and might be unable to pay off all his creditors and go bankrupt -- and Mike's Mortgage Company is gone. But Mike still has the $150k a month in bonuses he "earned" when things were going well.

I'll discuss more complications next time.

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(Deleted comment)
When one is feeling like tapping the screen and going "Hello? Is anybody listening?" is is very nice to get a comment saying "Yes, I am, at least". Thank you.

It is fair to assume that the basic gist of what I'm talking about is roughly similar to what happens in the UK, although that is an assumption. A lot of the really base law in the US about this stuff (such as the idea that all transfers of real property must be in writing) dates back to pre-revolutionary English law, or is at least derived from the same tradition as English law.

I would like your opinion: My decision to personalize this description by using names is inspired by Alice and Bob (see Wikipedia, xkcd). This tradition also uses Eve as the name of the eavesdropper. When I get into discussing ways that mortgages can go intentionally wrong, I was planning on using Eve as the bad actor (Hank buys a house from Eve with cash, but she doesn't mention the mortgage already on the house, Hank gets foreclosed on by Bob after Eve stops paying her note; Eve sues to foreclose on Henriette without bothering to buy the note first; Eve buys Henriette's note, and sells it once to Bruce and once to Bryan, etc). However, I'm a bit troubled by the Judeo-Christian "Eve is Evil incarnate" implications. I'm thinking of using Victor/Victoria or some other V-name for the "villain". Do you have an opinion?

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