U.S. BETS THE HOUSE / THE WALL STREET JOURNAL ( RECOMMENDED READING )

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SEPTEMBER 17, 2009, 5:49 P.M. ET.

U.S. Bets the House

By PETER EAVIS

More than half of U.S. residential mortgages are now being made by just three large banks.

It's a stunning change, but is it good for the housing market, and to what extent will it boost profits over the long-term for this elite trio, Wells Fargo, Bank of America and J.P. Morgan Chase?

Right now, housing remains on government life support. Treasury-backed entities are guaranteeing around 85% of new mortgages, while the Fed buys 80% of the securities into which these taxpayer-backed mortgages are packaged.

The optimistic take is that this support, though large, will shrink when market forces regain confidence. But there's a darker possible outcome: The emergency assistance is entrenching a system where the taxpayer takes the default risk on most mortgages, while a small number of large banks get a larger share of the fee revenue from originating and servicing mortgages.

That's what happening now. While big banks are originating lots of mortgages, they are selling nearly all of them on to Fannie Mae and Freddie Mac. Indeed, combined single-family mortgages held on balance sheet at J.P. Morgan, BofA and Wells Fargo actually fell by 3.5% in the first half of the year. Before the bust, those banks sold large amounts of loans to Fannie or Freddie, but they also held on to product like jumbo mortgages. The volumes for those large loans have now tumbled.

And even as their mortgage holdings fall, these banks are posting big jumps in fee revenue from mortgage banking. Combined, it was $14 billion in the first half, up 240% from $4.1 billion in the year-earlier period.

Granted, some of this increase came from marking up mortgage-servicing assets, but fees from writing huge amounts of new loans, fueled by refinancing, caused revenue to soar at BofA and Wells Fargo.

And these blowout revenues are partly down to increased market share following big mergers, like BofA's acquisition of Countrywide. The three originated 52% of mortgages in the first half, according to Inside Mortgage Finance, just over double these banks' market share in 2005. In servicing, their share is 49%, compared with 22% in 2005.

Regulators signed off on the mergers that created this dominance. Even without the urgency for saving weak banks created by the crisis, regulators have never focused primarily on mortgage share. That suggests they won't worry about increased concentration. What's more, they may like it that most mortgages go through three banks that they intend to regulate heavily.

Will the big three benefit? Large market share in mortgages could act as a drag if the housing market languishes after government support recedes. But getting a strong grip on mortgage fee income -- and avoiding credit and interest-rate risk by selling loans to the government -- could turn out to be a money-making strategy, even if, as expected, mortgage origination drops off from current levels.

And by making themselves indispensable for the functioning of the mortgage market, these banks are more likely to be rescued if they get into trouble. "It does make these institutions even more vital to public policy and thus even less likely to be allowed to fail," says Nicole Gelinas of the Manhattan Institute.

Rather than trying to implement change, the government appears to be reinforcing a system where it provides immense subsidies to an asset that periodically goes through highly leveraged speculative booms.

Despite the bust, conforming mortgages that qualify for government-backing remain mispriced. That can be seen in the fact that banks have no desire to keep the most common mortgage on their books. Wells Fargo Chief Executive John Stumpf recently said: "We're not putting on 30-year [fixed-rate] mortgages at these rates."

So why should the taxpayer take them?

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