Fannie, Freddie to Steal Banks' Crutches?

This post first appeared on Minyanville and Cirios Real Estate.

With mortgage rates at historic lows, housing prices plummeting, and Washington throwing billions at housing-market recovery efforts, why is it still so damn hard to get a loan?

And while the easy answer is that banks are flat-out broke, the real answer may lie in an esoteric corner of mortgage finance which has all but disappeared: warehouse lending.

In the heyday of the housing boom, small mortgage companies were able to compete with huge financial institutions by tapping so-called warehouse lines of credit. Using cash from their warehouse lender to fund loans at the closing table, as big banks do, these smaller mortgage shops could often provide better service than their bigger competitors, though at the same low rates.

Warehouse lenders, often big banks themselves -- remember Washington Mutual and Countrywide (Bank of America (BAC))? -- held onto loans until they were sold in the secondary market. Turnaround time could be anywhere from a few days to a few months for larger, more complex transactions.

The benefits to being able to finance one's own loans rather than just acting as a broker were numerous. Having a warehouse line gave mortgage bankers better control over the closing process, enabling them to beat out big banks in terms of response time and customer service.

By aggregating loans on a warehouse line, bankers could bundle them together and sell packages at a premium, rather than selling them off one by one. And since they could sell loans to any bank on the street, most such originators offered loan programs just as varied as those of even the biggest institutional lenders.

At the height of the boom, it was estimated that almost half of the over $3 trillion in annual loan production was first funded on a warehouse line.

As the mortgage market began to collapse, big purchasers stopped buying, and warehouse lines filled up with unwanted loans. Warehouse lenders began margin-calling clients, cutting off funding capacities, and capturing every penny they could from the few sales that actually went through.

The result, which can be plainly seen on websites like The Mortgage Lender Implode-o-Meter, was that hundreds of small bankers closed up shop.

Now, as banks scramble to handle the flood of requests for refinances at super-low interest rates, the mortgage industry is once again facing a credit crunch. By one estimate there's only $25 billion in available warehouse lines to support the $2.8 trillion in mortgages expected to be written next year.

Mortgage bankers I speak with say the only thing holding them back from giving out more loans is a lack of warehouse capacity.

According to the Wall Street Journal, one solution being floated by the Mortgage Bankers Association (or MBA) is for Fannie Mae (FNM) and Freddie Mac (FRE) to provide government-backed warehouse lines to the few intrepid mortgage bankers still eking out a living in this nightmarish market.

The MBA argues that, since big banks like JPMorgan (JPM), Citigroup (C) and Wells Fargo (WFC) don’t need access to warehouse lines, they’re pushing out the smaller guys and stymieing competition. There's little incentive for a Chase or a Citi to reopen its warehouse lending group, since the move would just allow competitors to grab market share from the very profitable business of originating loans.

While it makes logical sense for regulators to allow Fannie and Freddie to prop up this segment of the market, it may run contrary to other bank-friendly initiatives. Fees generated by writing new mortgages may be the only thing keeping the likes of Bank of America and Citigroup from tapping even more government support to stay afloat.