© Cengage Learning 1
CHAPTER 3
ROLE OF RESIDENTIAL MORTGAGE LENDING
IN THE ECONOMY
OBJECTIVES OF CHAPTER
Upon successful completion of this chapter, students should be able to:
Explain how changes in the business cycle affect real estate
sales activity and mortgage lending.
Explain the economic stimulus that housing and home sales
have on the economy
Understand how demographics influence housing demand and
homeownership rates
Understand how consumer savings impacts the ability for
lenders to provide funds for mortgage loans
Cite the impact of the government’s deficit spending on interest
rates and the supply of capital.
Identify three ways the Federal Reserve exercises monetary
control
Compare and contrast the functions of financial intermediaries,
mortgage lenders, and mortgage investors.
Explain why Money Market Certificates (MMCs) failed to
correct the problem brought about by inflation and excessive
credit demand.
© Cengage Learning 2
Discuss historical events over the most recent twenty years
in the economy, changes in interest rates and other
economic factors which had great affects on the mortgage
industry.
Such as, what happens to interest rates and the deficit
during times of war?
Name a few important economic events that might have
started the most recent demise of real estate values.
I. Introduction
II. Residential Mortgage Debt
A. The Effects of Low interest rates
III. Economic stimulus of housing
A. New and existing home sales
B. Economic and social value of housing
C. U.S. Homeownership rate
D. Demographic forces in housing
E. Capital formation
IV. Importance of Savings to Housing
A. Savings rates
B. Decline in the savings rate
V. Capital and mortgage markets
A. Users of credit
B. Interest rates
C. Competition for funds
D. Public debt vs. private debt
E. Monetary policy and interest rates
F. Federal Reserve Bank System
G. Countercyclical Nature of Real Estate
Teaching Tips
© Cengage Learning 3
SUGGESTED TRUE/FALSE QUIZ
1. Savings of individuals make up an insignificant
part of the funds required by the financial market.
2. Mortgage lending is part of the capital market.
3. Housing and related sectors account for less than 10 percent of
gross domestic product.
4. As a general rule, financial intermediaries can earn higher
yields on investments than individuals can.
VI. Financial intermediaries
A. How savers benefit
B. How mortgage borrowers benefit
C. Gross Profit spread
D. Interest rate risk
VII. Mortgage lenders and the Primary
Mortgage Market
A. Funding for mortgage debt
B. Mortgage investors
VIII. Recent trends in mortgage lending
A. Mortgage revenue bonds (MRBs)
B. Mortgage credit certificates (MCCs)
C. Builder bonds
Discuss the importance of saving and
responsible borrowing and how it will benefit
one’s future.
Which economic sectors are savers and which
are borrowers?
What type of lender will be around in the
future?
© Cengage Learning 4
5. Money market certificates (MMCs) have increased savings
inflows to banks and thrifts.
6. The Federal Reserve is responsible for fiscal and monetary
control.
7. Low interest rates usually do not stimulate the housing market
because too many people are out of work.
8. The primary risk to portfolio lenders is interest rate risk.
9. The term financial intermediary refers to the person who is a
middle man between financial institutions.
10. in 2010, the value of all homes in the U.S. was approximately
$17 trillion.
11. Builder bonds are used to raise direct capital for home builders.
12. Life insurance companies can be classified as a mortgage
investor.
MULTIPLE CHOICE QUESTIONS. More than one answer may be
correct – select all correct answers. (Correct answers are italicized.)
1. Disintermediation usually occurs under the following circumstances
except when:
© Cengage Learning 5
a. Demand for credit is high.
2. Real estate activity and mortgage lending usually expand when the
d. Interest rates are high.
3. Increased borrowing by the government results in all of the following
except:
d. Increased competition for funds.
© Cengage Learning 6
4. When the Federal Reserve buys securities and issues a check drawn
upon itself, which method of credit control is it exercising?
a. It is decreasing the supply of money by discounting commercial
paper.
5. Which of the following is not an example of a mortgage lender?
a. Commercial bank
SUGGESTED SHORT ESSAY QUESTIONS
1. If demand for funds is high and corporate bonds offer the same rate as
mortgages, funds will generally flow to bonds. Explain why this is
true, and what actions mortgage lenders can take to ease this problem.
ANSWER: Mortgage loans are less attractive to investors because
they lack uniformity, are less liquid, and can be “tied up” in lengthy
© Cengage Learning 7
2. Why is mortgage lending impacted negatively by excessive
governmental borrowing?
ANSWER: The key ingredient for high mortgage lending activity is
the interest rate. The interest rate is established by the demand for
© Cengage Learning 8
ANSWERS TO ORAL DISCUSSION POINTS
The discussion points at the end of each chapter are intended for oral
discussion in class. Suggested answers/points to emphasize for the
questions are found below.
1. Real estate and mortgage lending are a major part of the American
economy. Examine and explain the magnitude of their involvement in
the economy.
ANSWER: Economists have concluded that housing and related
sectors account for about 21 percent of the Gross Domestic Product
(GDP) – a measure of the nation’s total output of goods and services.
Examples of the economic importance of housing, and therefore
© Cengage Learning 9
2. Real estate and mortgage lending are significantly impacted by changes in
the economy, especially interest rates. What was the impact on mortgage
lending of the dramatic drop in interest rates in 2001-02? Why did interest
rates drop so much?
ANSWER: The low interest rates during this period (30-year rates
reached a low of 5.75 in 2002) allowed record originations of over $2
trillion in 2002. These low interest rates allowed more people to
3. What is the difference between financial intermediaries, mortgage lenders
and mortgage investors?
ANSWER: The more modern and clearly more descriptive term, financial
The primary economic function of a residential mortgage lender is to lend
© Cengage Learning 10
4. How does the “Fed” attempt to manage the economy? What tools are most
important?
ANSWER: An important element in determining interest rates is monetary
policy. Monetary policy (as controlled by the Federal Reserve) occurs when
the supply of money is controlled rather than interest rates. Thus, if the
© Cengage Learning 11
5. As a general rule, from where does the money for residential mortgage
lending come?
ANSWER: The funds required for capital formation are derived primarily
from the savings of individuals and businesses. This process of capital
6. How do demographic forces impact real estate and the mortgage markets?
ANSWER: Demographic forces are contributing to continued strength in
housing demand. Couples reaching their home buying years, new
immigrants and certain minority groups are creating demand for housing.