Several high-profile mortgage lenders, including American Home Mortgage, closed their doors this week and stopped funding loans.  Others dramatically limited their list of “eligible” borrowers.

Many buyers and sellers across the country have been stranded at the closing table without funds this week, only adding to the confusion.

Because the story is not getting much press, let’s talk about why lenders are having to shut down.  It’s not because they made bad loans in the past, per se. 

It’s because their only function is to serve as a go-between for Wall Street and home owners.

Different from mortgage banks, a “traditional” bank collects deposits from customers and then lends some of those deposits in the form of mortgages.  Then, a special quasi-government agency steps in and buys the mortgages from the bank, in effect, “replacing” the deposits.

If you’ve heard of Fannie Mae or Freddie Mac, they are the quasi-government agencies we’re talking about.  Their mandate is to buy home loans from banks that meet certain criteria.

For a mortgage bank, though, Fannie and Freddie are not the buyers — it’s hedge funds, pension funds, international investors, and others.  If these end investors decide to stop buying loans, the mortgage bank can’t play matchmaker anymore. 

And that is precisely what’s happening.

Unlike Fannie and Freddie, mortgage banks rely on investors to provide money to their clients and, now that many investors closed the spigot on mortgage loans, many mortgage banks have no choice but to fold.

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