Traditional mortgage products are already on their way to becoming obsolete at many institutions.

That's the view of Karen Shaw Petrou, president of ISD/Shaw Inc., a Washington consulting firm specializing in regulatory issues.

What's more, she says, an excessive focus by lenders, especially thrifts, on the same old products and same old customers will only speed obsolescence.

Banks and thrifts have an edge in the mortgage market, she says, stemming from their ability to add value to mortgage products.

"Although Fannie and Freddie are clearly going after many segments of the business, they still cannot expand their charters enough to tie savings products for home down payments with discounted mortgages," she said at a thrift convention in Puerto Rico late last year. "They cannot package home lending with home insurance, or mortgage counseling with paid tax preparation and financial planning services."

Ms. Petrou pointed out in her talk that the transformation of the mortgage industry has parallels in other areas of banking. For example, credit cards have virtually replaced consumer installment loans. And the rapid development of the commercial paper market has drastically changed commercial lending.

What has transformed the mortgage business? Ms. Petrou said the changes have been demographic, technological, and regulatory. The biggest factor has been the enormous growth of Fannie Mae and Freddie Mac - formally the Federal National Mortgage Association and Federal Home Loan Mortgage Corp. - which commoditized conventional home loans.

"What products they purchase, what loans they back, what technological standards they dictate - all define who can originate mortgage loans on what terms to which consumers in what markets," she said.

Ms. Petrou also said both mortgage bankers and Fannie and Freddie are required to hold less capital than portfolio lenders and thus can operate with far narrower spreads. And she sees little prospect that this will change.

Because Fannie and Freddie "have driven down spreads to noneconomic levels for competing portfolio lenders, many in the industry have retreated to nonconforming loan origination and securitization," she said. This means VA, FHA, and subprime loans on the low end and jumbos on the high end.

In an interview, she warned that the subprime market may be especially dangerous right now because of the chance that the economy may soften. "These borrowers are by definition people without the resources to weather a few months of unemployment," she said. While the risk-adjusted spreads in "B" and "C" lending appear adequate right now, they are rapidly declining, she said.

Ms. Petrou also noted that the role of the Federal Home Loan banks appeared on the verge of being transformed. "Recent proposals ... have led some to wonder if the Home Loan banks have a case of Fannie-envy," she said.

She noted that Fannie and Freddie differ from the Home Loan banks in having private shareholders, while the banks are cooperatives. "Many on the Hill may be willing to see the banks expand," she said, "especially as the dire condition of several of them becomes clear."

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