Mortgage Lenders Face Long Rehab

Editor's note: The credit markets have been the epicenter of volatility on Wall Street throughout the second half of 2007. Falling home prices and subsequent defaults on mortgage-backed securities led to a liquidity crisis that's expected to get messier in 2008. The outlook for companies in the financial sector and beyond is dim as corporate profits weaken amid a weakening economy and rising inflationary pressures. This is the first installment in an ongoing series about how the tumult in the credit markets will affect the economy and the markets in 2008.

Potential home buyers have far fewer choices when applying for a loan these days.

Largely gone are the subprime, jumbo and other exotic options that were readily available during the housing boom. Now the only type of mortgages on the block are the blandest around, all conforming to underwriting standards set by government-backed loan guarantors.

For mortgage lenders and banks, such as Countrywide(CFC Quote), Washington Mutual(WM Quote), Wells Fargo(WFC Quote) and Wachovia(WB Quote), and for armies of mortgage brokers around the country, their business recoveries may center on how long the all-conforming, all-the-time trend persists.

That's a horizon likely not visible for several years, much less 2008. And lenders may have to downsize and temper profit expectations going forward, some analysts say.

"The mortgage industry will not ever again be the way it was in the last four years," says Ajay Rajakhyaksha, head of U.S. fixed income strategy at Barclays Capital. Businesses that relied on mortgage lending will have to shrink down and expect to make less money going forward, he says.

An explosion of exotic mortgage underwriting dominated the market over the past four years, fueling outsized profits and excess leverage for borrowers, banks and Wall Street debt underwriters, but it ground to a halt in the second half of 2007, when a credit crunch gripped the globe.