Disruption in the Mortgage Industry

It was Friday afternoon, and the financial markets had just closed for the day… but the mood was tense in the boardroom of Gateway Savings & Loan.

President I. Owen Funderburg knew he needed to steel his resolve, but he couldn’t help pacing. He needed to find an answer to an unexpected problem.

The year was 1980, and the Federal Reserve (the Fed) had just raised interest rates again – sending shockwaves through the small savings and loan bank’s once-steady world.

Gateway’s ledger was bleeding red, and the phone lines buzzed with worried depositors demanding to withdraw their money. The threat of a bank run was imminent.

Funderburg understood the problem very well.

Gateway Savings & Loan had built a large portfolio of fixed-rate mortgages throughout the 1970s, when interest rates were more reasonable.

But with Paul Volcker at the Fed hellbent on whipping inflation by raising interest rates dramatically, the bank’s short-term deposit costs now exceeded its loan yields… making its mortgage portfolio a heavy weight around Funderburg’s neck.

The only question was – what should Gateway do about it? It was the same problem every savings & loan outfit was facing across America.

As Funderburg paced the boardroom, the weight of responsibility pressed on him. He couldn’t help but think of what would happen if the institution failed – if he failed.

Funderburg pictured the boarded-up windows of another failed thrift bank and the line of anxious customers outside clamoring to withdraw their life savings… and he knew he couldn’t let that vision come to pass.

Gateway’s Solution

Gateway Savings & Loan was something of a pillar in north St. Louis. It was a small thrift bank where working-class residents could get affordable mortgages and the direct financial guidance that larger banks wouldn’t bother to offer.

For many customers, to lose Gateway would mean more than just the loss of a neighborhood bank. It would represent a loss of hope. The neighborhoods Gateway served would likely see credit dry up, local businesses struggle, and family dreams of homeownership slip away.

And it wouldn’t stop at St. Louis.

Funderburg knew that thrifts everywhere were desperate – hemorrhaging deposits, facing losses they couldn’t hide, and holding mortgage portfolios that had suddenly become anchors dragging them under.

If institutions like Gateway were to fail en masse, the effects would ripple across the country. Whole neighborhoods would lose access to credit, real estate values would spiral, and faith in local banking would evaporate. People would learn the hard way what happens when the system designed to make homeownership widely accessible collapses.

So Funderburg was determined to be proactive. Having risen through the banking ranks in the segregated South, he knew what was at stake. Gateway was a bastion for underserved families in St. Louis, and it often provided a lifeline for customers in neighborhoods that larger banks ignored.

That’s why he called the emergency board meeting after market close on a Friday afternoon.

He wanted all hands on deck, and he made it clear that they would discuss every possible idea – no matter how long it would take.

Artist’s rendering of Gateway Savings & Loan’s boardroom in 1980

Fortunately, a prominent real estate broker sat on Gateway’s board, and – after some initial discussion – he put forth an interesting idea.

There are investors out there – far from this boardroom and even far from St. Louis – who might want to buy the mortgages we hold on our balance sheet… for the right price, of course. I would be willing to put some calls out to my network if we want to consider this option.

It was something of a radical idea in the pre-Internet age – back when business was often conducted in person and on paper. Wheeling and dealing with investment assets like this may have been common on Wall Street, but not so much in the Midwest.

After some discussion and putting the idea to a vote, it was settled. Gateway would seek to stop the bleeding by selling the bulk of its mortgage portfolio for immediate cash. Then it could show depositors that the bank had everything under control.

Sure enough, Gateway found that there was ample investor appetite for its mortgages, given that the thrift was willing to sell them at a discount to the unpaid principal balance.

These deals provided investors with a suitable return and monthly cash flow, and they provided Gateway with the cash infusion it needed to shore up its balance sheet and reset its relationship between deposit costs and loan yield.

The sale was invisible to most. But for Funderburg, it was made possible by something of a secret world – the secondary market for buying and selling mortgages.

Of course, the days when local banks originated most of the mortgages in their local area are long gone. Today, roughly 64% of all mortgages are originated through online-first lenders and digital platforms. And this dynamic has only increased the number of mortgages sold into the secondary market each year.

An Industry Ripe for Disruption

When we think about the lending industry, we tend to think about what happens on the front end – a consumer applies for a loan from a lending institution. If approved, the borrower gets financing, and the lender receives a small fee up front and the right to receive interest payments from the loan going forward.

However, lending institutions only keep a small fraction of the loans they originate on the balance sheet. That’s because holding loans reduces the capital they have available to make new loans, which is their core business.

For this reason, lenders tend to sell the majority of the loans they create shortly after origination. This process starts with a manual review of the loans to determine which ones to sell and which ones to keep.

Then, lenders must determine whether they can sell a loan directly to an institutional investor or if they need to pool their loans into a mortgage-backed security through the securitization process.

The industry’s conventional process for selling loans is largely manual. For instance, initial offers to sell might be made via telephone or negotiated directly with buyers or brokers. This requires the manual preparation of loan packages, due diligence, and compliance checks to ensure that the loans meet investor standards.

As a result, it can take up to 120 days for a lending institution to sell a loan, with the average time being 14 weeks (98 days). But that’s not the end of the transaction. Once a loan is sold, the settlement and funding process typically takes another 10 to 21 days.

All in all, it can take four to five months to complete the entire process of selling a single loan. And there are substantial costs involved, given the manual work required.

Obviously, that’s a terribly inefficient process… and it has made the mortgage industry ripe for disruption. In fact, bleeding-edge technology is bringing the industry into the digital age as we speak…

The Tools of Disruption

A massive wave of innovation is rolling across the mortgage landscape right now, quietly rewiring the financial infrastructure beneath the surface. While Funderburg and his colleagues once relied on phone calls, paper files, and handshakes, today’s market is being reshaped by the convergence of two technologies: artificial intelligence (AI) and blockchain technology.

Across the industry, a new crop of financial technology (fintech) companies is seizing this opportunity. And these firms aren’t just tinkering… they are rebuilding the entire secondary market system from the ground up.

Where the legacy systems required manual loan reviews and reams of compliance paperwork, the industry’s disruptors are using AI-driven analytics to instantly assess borrower risk, verify compliance, and identify which mortgages are most attractive for a lender to sell.

Just to give us some context, the top AI technology on the market today can scan and validate hundreds of pages of loan documents in minutes, flagging anomalies before a human ever steps in.

Then every step of a mortgage’s life can be recorded on proprietary blockchain technology – an immutable and transparent digital ledger that’s visible to any authorized party. This also eradicates manual labor, as every mortgage sale can be logged as a secure transaction.

This means no more back-and-forth emails, no lost pages, no data re-keying, and no miscommunications. A blockchain’s digital chain of custody allows all parties – lenders, investors, regulators – to see the same truth in real time.

The impact on efficiency is profound.

As mentioned earlier, it took four to five months of labor to complete the process of selling a single mortgage under legacy processes. With AI and blockchain tech, sales can now be completed in a matter of days… all while slashing transaction costs by more than 50%.

Consider that the secondary market for residential mortgages in the US is now roughly $13 trillion, we’re talking about tens, maybe hundreds of billions in cost savings here – all with fast liquidity and lower risk.

And for consumers, these technological advances represent a fundamental shift in the homebuying experience.

Empowering Consumers

With AI and blockchain, borrowers can expect much faster loan approvals and closings. Instead of waiting months, the whole mortgage process – from application to settlement – can be completed in just a couple of weeks.

The shift to digital platforms lets borrowers complete most steps from their phones or computers. No more mountains of paperwork or repeat trips to the bank – just seamless, on-demand updates and e-signatures.

And enhanced transparency, powered by a blockchain’s digital ledger, means every step of the process can be easily tracked and verified. This reduces the risk of errors or unexpected changes.

Perhaps most importantly, AI-powered credit assessments are expanding access for homebuyers.

Lenders using alternative data and smarter algorithms can offer mortgages to more people. This includes self-employed business owners, gig workers, and those with non-traditional credit backgrounds – all people who traditional lenders struggled with previously.

Put it all together, this tech enabled approach to lending is broadening the path to homeownership for millions of people.

So the convergence of AI and blockchain is not just remaking the mortgage market for banks and investors – it is helping families realize the dream of homeownership with less stress and greater confidence.

The Self-Directed Investor’s Opportunity

For self-directed investors, the transformation of the mortgage market represents a generational opportunity to participate in an asset class once dominated by institutional insiders and Wall Street giants.

The confluence of AI and blockchain technology is driving a new era of access, efficiency, and transparency that unlocks the secondary mortgage market for motivated individuals like never before.

A number of fintech companies are automating everything from underwriting to closing and in the process building high-growth businesses with recurring revenue streams and powerful network effects. Meanwhile, innovative blockchain projects are delivering new levels of efficiency, transparency, and security for both lenders and investors.

Investing in these companies and projects allows investors to participate in the massive value created by digitizing a $13 trillion marketplace – all while tapping into revenue derived from software licensing, transaction processing, compliance automation, and marketplace activity as the digital-first mortgage industry comes into being.

As more lenders and real estate professionals scramble to modernize their platforms, and as regulators nudge incumbents toward transparency and security, the very companies at the heart of the transformation stand to reap the lion’s share of growth.

In short, this is an exciting opportunity for self-directed investors to capitalize on the mortgage revolution while it’s in its infancy. As the mortgage market is rebuilt in real time, the returns from owning the tools, platforms, and protocols behind the curtain could prove to be asymmetric over time.

As Jeff likes to say, we have so much to look forward to.

Joe Withrow
Senior Analyst, The Bleeding Edge