Author Archives: David Reiss

The Missing Piece in The Affordable Housing Puzzle

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The National Low Income Housing Coalition has posted The Gap: A Shortage of Affordable Homes. The report opens,

One of the biggest barriers to economic stability for families in the United States struggling to make ends meet is the severe shortage of affordable rental homes. The housing crisis is most severe for extremely low income renters, whose household incomes are at or below the poverty level or 30% of their area median income (see Box 1). Facing a shortage of more than 7.2 million affordable and available rental homes, extremely low income households account for nearly 73% of the nation’s severely cost-burdened renters, who spend more than half of their income on housing.

Even with these housing challenges, three out of four low income households in need of housing assistance are denied federal help with their housing due to chronic underfunding. Over half a million people were homeless on a single night in 2017 and many more millions of families without assistance face difficult choices between spending their limited incomes on rent or taking care of other necessities like food and medical care. Despite the serious lack of affordable housing, President Trump proposes further reducing federal housing assistance for the lowest income households through budget cuts, increased rents and work requirements.

Based on the American Community Survey (ACS), this report presents data on the affordable housing supply, housing cost burdens, and the demographics of severely impacted renters. The data clearly illustrate a chronic and severe shortage of affordable homes for the lowest income renters who would be harmed even more by budget cuts  and other restrictions in federal housing programs. (2, citations omitted)

The report’s key findings include,

  • The nation’s 11.2 million extremely low income renter households account for 25.7% of all renter households and 9.5% of all households in the United States.
  • The U.S. has a shortage of more than 7.2 million rental homes affordable and available to extremely low income renter households. Only 35 affordable and available rental homes exist for every 100 extremely low income renter households.
  • Seventy-one percent of extremely low income renter households are severely cost-burdened, spending more than half of their incomes on rent and utilities. They account for 72.7% of all severely cost-burdened renter households in the United States.
  • Thirty-two percent of very low income, 8% of low income, and 2.3% of middle income renter households are severely cost-burdened.
  • Of the eight million severely cost-burdened extremely low income renter households, 84% are seniors, persons with disabilities, or are in the labor force. Many others are enrolled in school or are single adults caring for a young child or a person with a disability. (2, citations omitted)

While the report does show how wrongheaded the Trump Administration’s proposed cuts to housing subsidies are, I was surprised that it did not address at all the impact of local zoning policies on housing affordability. There is no way that we are going to address the chronic shortage in affordable housing by subsidies alone.

The federal government will need to disincentivize local governments from implementing land use policies that keep affordable housing from being built in communities that have too little housing. These rules make single family homes too expensive by requiring large lots and make it too difficult to build multifamily housing. We cannot seriously tackle the affordability problem without addressing restrictive local land use policies.

Nonbanks and The Next Crisis

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Researchers at the Fed and UC Berkeley have posted Liquidity Crises in the Mortgage Markets. The authors conclusions are particularly troubling:

The nonbank mortgage sector has boomed in recent years. The combination of low interest rates, well-functioning GSE and Ginnie Mae securitization markets, and streamlined FHA and VA programs have created ample opportunities for nonbanks to generate revenue by refinancing mortgages. Commercial banks have been happy to supply warehouse lines of credit to nonbanks at favorable rates. Delinquency rates have been low, and so nonbanks have not needed to finance servicing advances.

In this paper, we ask “What happens next?” What happens if interest rates rise and nonbank revenue drops? What happens if commercial banks or other financial institutions lose their taste for extending credit to nonbanks? What happens if delinquency rates rise and servicers have to advance payments to investors—advances that, in the case of Ginnie Mae pools, the servicer cannot finance, and on which they might take a sizable capital loss?

We cannot provide reassuring answers to any of these questions. The typical nonbank has few resources with which to weather these shocks. Nonbanks with servicing portfolios concentrated in Ginnie Mae pools are exposed to a higher risk of borrower default and higher potential losses in the event of such a default, and yet, as far as we can tell from our limited data, have even less liquidity on hand than other nonbanks. Failure of these nonbanks in particular would have a disproportionate effect on lower-income and minority borrowers.

In the event of the failure of a nonbank, the government (through Ginnie Mae and the GSEs) will probably bear the majority of the increased credit and operational losses that will follow. In the aftermath of the financial crisis, the government shared some mortgage credit losses with the banking system through putbacks and False Claims Act prosecutions. Now, however, the banks have largely retreated from lending to borrowers with lower credit scores and instead lend to nonbanks through warehouse lines of credit, which provide banks with numerous protections in the event of nonbank failure.

Although the monitoring of nonbanks on the part of the GSEs, Ginnie Mae, and the state regulators has increased substantially over the past few years, the prudential regulatory minimums, available data, and staff resources still seem somewhat lacking relative to the risks. Meanwhile, researchers and analysts without access to regulatory data have almost no way to assess the risks. In addition, although various regulators are engaged in micro-prudential supervision of individual nonbanks, less thought is being given, in the housing finance reform discussions and elsewhere, to the question of whether it is wise to concentrate so much risk in a sector with such little capacity to bear it, and a history, at least during the financial crisis, of going out of business. We write this paper with the hope of elevating this question in the national mortgage debate. (52-53)

As with last week’s paper on Mortgage Insurers and The Next Housing Crisis, this paper is a wake-up call to mortgage-market policymakers to pay attention to where the seeds of the next mortgage crisis may be hibernating, awaiting just the right conditions to sprout up.

De Facto Housing Finance Reform

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photo by The Tire Zoo

David Finkelstein, Andreas Strzodka and James Vickery of the NY Fed have posted Credit Risk Transfer and De Facto GSE Reform. It opens,

Nearly a decade into the conservatorships of Fannie Mae and Freddie Mac, no legislation has yet been passed to reform the housing finance system and resolve the long-term future of these two government-sponsored enterprises (GSEs). The GSEs have, however, implemented significant changes to their operations and practices over this period, even in the absence of legislation. The goal of this paper is to summarize and evaluate one of the most important of these initiatives – the use of credit risk transfer (CRT) instruments to shift mortgage credit risk from the GSEs to the private sector.

Fannie Mae and Freddie Mac have significant mortgage credit risk exposure, largely because they provide a credit guarantee to investors on the agency mortgage-backed securities (MBS) they issue. Since the CRT programs began in 2013, Fannie Mae and Freddie Mac have transferred to the private sector a portion of the credit risk on approximately $1.8 trillion in single-family mortgages (as of December 2017; source: Fannie Mae, 2017, Freddie Mac, 2017). The GSEs have experimented with a range of different risk transfer instruments, including reinsurance, senior-subordinate securitizations, and transactions involving explicit lender risk sharing. The bulk of CRT, however, has occurred via the issuance of structured debt securities whose principal payments are tied to the credit performance of a reference pool of securitized mortgages. A period of elevated mortgage defaults and losses will  trigger automatic principal write-downs on these CRT bonds, partially offsetting credit losses experienced by the GSEs.

Our thesis is that the CRT initiative has improved the stability of the  housing finance system and advanced a number of important objectives of GSE reform. In particular the CRT programs have meaningfully reduced the exposure of the Federal government to mortgage credit risk without disrupting the liquidity or stability of secondary mortgage markets. In the process, the CRT programs have created a new financial market for pricing and trading mortgage credit risk, which has grown in size and liquidity over time. Given diminished private-label securitization activity in recent years, these CRT securities are one of the primary ways for private-sector capital market investors to gain exposure to residential mortgage credit risk.

An important reason for this success is that the credit risk transfer programs do not disrupt the operation of the agency MBS market or affect the risks facing agency MBS investors. Because agency MBS carry a GSE credit guarantee, agency MBS investors assume that they are exposed to interest rate risk and prepayment risk, but not credit risk. This reduces the set of parameters on which pass-through MBS pools differ from one another, improving the standardization of the securities underlying the liquid to-be-announced (TBA) market where agency MBS mainly trade. Even though the GSEs now use CRT structures to transfer credit risk to a variety of private sector investors, these arrangements do not affect agency MBS investors, since the agency MBS credit guarantee is still being provided only by the GSE. In other words, the GSE stands in between the agency MBS investors and private-sector CRT investors, acting in a role akin to a central counterparty.

Ensuring that Fannie Mae and Freddie Mac’s credit risk sharing efforts occur independently of the agency MBS market is important for both market functioning and financial stability. The agency MBS market, which remains one of the most liquid fixed income markets in the world, proved to be quite resilient during the 2007-2009 financial crisis, helping to support the supply of mortgage credit during that period. The agency market financed $2.89 trillion of mortgage originations during 2008 and 2009, experiencing little drop in secondary market trading volume during that period. In contrast, the non-agency MBS market, where MBS investors are exposed directly to credit risk, proved to be much less stable; Issuance in this market essentially froze in the second half of 2007, and has remained at low levels since that time.4 (1-2, citations and footnotes omitted)

One open question, of course, is whether the risk transfer has been properly priced. We won’t be able to fully answer that question until the next crisis tests these CRT securities. But in the meantime, we can contemplate the authors’ conclusion:

the CRT program represents a valuable step forward towards GSE
reform, as well as a basis for future reform. Many proposals have been put forward for long-term reform of mortgage market since the GSE conservatorships began in 2008. Although the details of these proposals vary, they generally share in common the goals of

(1) ensuring that mortgage credit risk is borne by the private sector (probably with some form of government backstop and/or tail insurance to insure catastrophic risk and stabilize the market during periods of stress), while

(2) maintaining the current securitization infrastructure as well as the standardization and liquidity of agency MBS markets.

The credit risk transfer program, now into its fifth year, represents an effective mechanism for achieving these twin goals. (21, footnote omitted)

Sustainable Housing for FHA Borrowers

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photo by Michael Daddino

Federal Reserve Bank of New York

Donghoon Lee and Joseph Tracy of the NY Fed have posted a staff report, Long-Term Outcomes of FHA First-Time Homebuyers. It opens,

The Commissioner of the Federal Housing Administration (FHA), David Stevens, in remarks delivered on December 12, 2009, defined the purpose of the FHA as follows. “As a mission-driven organization, FHA’s goal is to provide sustainable homeownership options for qualified borrowers.” These remarks followed a remarkable increase in the scope of the FHA mortgage insurance program in response to the financial crisis and housing bust. This comment by Commissioner Stevens is important in that it clarifies a goal of the FHA program. However, this clarity was not followed up by the FHA with a definition of “sustainable homeownership.” Nor was there any documented attempt by the FHA to develop metrics to track their progress toward this objective, or a commitment by the FHA to make this information available to the public in the future.

Program evaluation is an integral part of any effective program—government or private. We illustrate in this paper that advances in data availability offer the opportunity for the FHA to both define what it means by sustainable homeownership and to measure its progress against this definition. We believe that it would be beneficial for the FHA to be transparent in this effort and to report on not only its definition and metrics, but also on its progress on an annual basis. Improved tracking of long-term outcomes of FHA borrowers will better help inform the FHA on program design. This should lead to improved outcomes over time and enhanced public support.

We focus our analysis on first-time homebuyers who are an important market segment for the FHA. The mission of sustainable homeownership is particularly relevant for these new homeowners. The benefits of a government mortgage insurance program that helps to facilitate the transition from renting to owning rests importantly on the success of these new borrowers in remaining homeowners in the future. However, to date, the FHA has not systematically tracked the progress of its first-time homebuyers after they pay off their credit risk to the FHA. We use the New York Fed’s Consumer Credit Panel (CCP) data to do this analysis starting with the 2002 cohort of FHA first-time homebuyers. (1, footnotes omitted)

This is inarguably right. The FHA should set forth performance metrics and provide annual progress reports for them. For too long, the FHA has cherry-picked metrics without providing a holistic perspective on its performance. The authors conclude,

A stated mission of the FHA mortgage insurance program is to support sustainable homeownership. An examination of the history of the FHA program illustrates a strong initial focus on sustainability, but legislated changes in the 1950s and early 1960s shifted the focus to affordability. If sustainability remains an important goal for the FHA, then it would be desirable for the FHA to define what they mean by sustainability and to track their performance over time. Only by being transparent and holding themselves accountable can the FHA improve on this objective over time. (14)

Amen to that.

Ghost of A Crisis Past

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photo by Chandres

The Royal Bank of Scotland settled an investigation brought by New York Attorney General Schneiderman arising from mortgage-backed securities it issued in the run up to the financial crisis. RBS will pay a half a billion dollars. That’s a lot of money even in the context of the settlements that the federal government had wrangled from financial institutions in the aftermath to the financial crisis. The Settlement Agreement includes a Statement of Facts which RBS has acknowledged. Many settlement agreements do not include such a statement, leaving the dollar amount of the settlement to do all of the talking. We are lucky to see what facts exactly RBS is “acknowledging.”

The Statement of Facts found that assertions in the offering documents for the MBS were inaccurate and the securities have lost billions of dollars in collateral. These losses led to “shortfalls in principal and interest payments, as well as declines in the market value of their certificates.” (Appendix A at 2)

The Statement of Facts outlines just how RBS deviated from the statements it made in the offering documents:

RBS’s Representations to Investors

11. The Offering Documents for the Securitizations included, in varying forms, statements that the mortgage loans were “originated generally in accordance with” the originator’s underwriting guidelines, and that exceptions would be made on a “case-by-case basis…where compensating factors exist.” The Offering Documents further stated that such exceptions would be made “from time to time and in the ordinary course of business,” and disclosed that “[l]oans originated with exceptions may result in a higher number of delinquencies and loss severities than loans originated in strict compliance with the designated underwriting guidelines.”

12. The Offering Documents often contained statements, in varying forms, with respect to stated-income loans, that “the stated income is reasonable for the borrower’s employment and that the stated assets are consistent with the borrower’s income.”

13. The Offering Documents further contained statements, in varying forms, that each mortgage loan was originated “in compliance with applicable federal, state and local laws and regulations.”

14. The Offering Documents also included statements regarding the valuation of the mortgaged properties and the resulting loan-to-value (“LTV”) ratios, such as the weighted-average LTV and maximum LTV at origination of the securitized loans.

15. In addition, the Offering Documents typically stated that loans acquired by RBS for securitization were “subject to due diligence,” often described as including a “thorough credit and compliance review with loan level testing,” and stated that “the depositor will not include any loan in a trust fund if anything has come to the depositor’s attention that would cause it to believe that the representations and warranties of the related seller regarding that loan will not be accurate and complete in all material respects….”

The Actual Quality of the Mortgage Loans in the Securitizations

16. At times, RBS’s credit and compliance diligence vendors identified a number of loans as diligence exceptions because, in their view, they did not comply with underwriting guidelines and lacked adequate compensating factors or did not comply with applicable laws and regulations. Loans were also identified as diligence exceptions because of missing documents or other curable issues, or because of additional criteria specified by RBS for the review. In some instances, RBS disagreed with the vendor’s view. Certain of these loans were included in the Securitizations.

17. Additionally, some valuation diligence reports reflected variances between the appraised value of the mortgaged properties and the values obtained through other measures, such as automated valuation models (“AVMs”), broker-price opinions (“BPOs”), and drive-by reviews. In some instances, the LTVs calculated using AVM or BPO valuations exceeded the maximum LTV stated in the Offering Documents, which was calculated using the lower of the appraised value or the purchase price. Certain of these loans were included in the Securitizations.

18. RBS often purchased and securitized loans that were not part of the diligence sample without additional loan-file review. The Offering Documents did not include a description of the diligence reports prepared by RBS’s vendors, and did not state the size of the diligence sample or the number of loans with diligence exceptions or valuation variances identified during their reviews.

19. At times, RBS agreed with originators to limit the number of loan files it could review during its due diligence. Although RBS typically reserved the right to request additional loan-level diligence or not complete the loan purchase, in practice it rarely did so. These agreements with originators were not disclosed in the Offering Documents.

20. Finally, RBS performed post-securitization reviews of certain loans that defaulted shortly after securitization. These reviews identified a number of loans that appeared to breach the representations and warranties contained in the Offering Documents. Based on these reviews, RBS in some instances requested that the loan seller or loan originator repurchase certain loans. (Appendix A at 4-5)

Some of these inaccuracies are just straight-out misrepresentations, so they would not have been caught at the time by regulators, even if regulators had been looking. And that’s why, ten years later, we are still seeing financial crisis lawsuits being resolved.

It is not clear that these types of problems can be kept from infiltrating the capital market once greed overcomes fear over the course of the business cycle. That’s why it is important for individual actors to suffer consequences when they allow greed to take the driver’s seat. We still have not figured out how to effectively address tho individual actions that result in systemic harm.

Mortgage Insurers and The Next Housing Crisis

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photo by Jeff Turner

The Inspector General of the Federal Housing Finance Agency has released a white paper on Enterprise Counterparties: Mortgage Insurers. The Executive Summary reads,

Fannie Mae and Freddie Mac (the Enterprises) operate under congressional charters to provide liquidity, stability, and affordability to the mortgage market. Those charters, which have been amended from time to time, authorize the Enterprises to purchase residential mortgages and codify an affirmative obligation to facilitate the financing of affordable housing for low- and moderate-income families. Pursuant to their charters, the Enterprises may purchase single-family residential mortgages with loan-to-value (LTV) ratios above 80%, provided that these mortgages are supported by one of several credit enhancements identified in their charters. A credit enhancement is a method or tool to reduce the risk of extending credit to a borrower; mortgage insurance is one such method. Since 1957, private mortgage insurers have assumed an ever-increasing role in providing credit enhancements and they now insure “the vast majority of loans over 80% LTV purchased by the” Enterprises. In congressional testimony in 2015, Director Watt emphasized that mortgage insurance is critical to the Enterprises’ efforts to provide increased housing access for lower-wealth borrowers through 97% LTV loans.

During the financial crisis, some mortgage insurers faced severe financial difficulties due to the precipitous drop in housing prices and increased defaults that required the insurers to pay more claims. State regulators placed three mortgage insurers into “run-off,” prohibiting them from writing new insurance, but allowing them to continue collecting renewal premiums and processing claims on existing business. Some mortgage insurers rescinded coverage on more loans, canceling the policies and returning the premiums.  Currently, the mortgage insurance industry consists of six private mortgage insurers.

In our 2017 Audit and Evaluation Plan, we identified the four areas that we believe pose the most significant risks to FHFA and the entities it supervises. One of those four areas is counterparty risk – the risk created by persons or entities that provide services to Fannie Mae or Freddie Mac. According to FHFA, mortgage insurers represent the largest counterparty exposure for the Enterprises. The Enterprises acknowledge that, although the financial condition of their mortgage insurer counterparties approved to write new business has improved in recent years, the risk remains that some of them may fail to fully meet their obligations. While recent financial and operational requirements may enhance the resiliency of mortgage insurers, other industry features and emerging trends point to continuing risk.

We undertook this white paper to understand and explain the current and emerging risks associated with private mortgage insurers that insure loan payments on single-family mortgages with LTVs greater than 80% purchased by the Enterprises. (2)

It is a truism that the next crisis won’t look like the last one. It is worth heeding the Inspector General’s warning about the

risks from private mortgage insurance as a credit enhancement, including increasing volume, high concentrations, an inability by the Enterprises to manage concentration risk, mortgage insurers with credit ratings below the Enterprises’ historic requirements and investment grade, the challenges inherent in a monoline business and the cyclic housing market, and remaining unpaid mortgage insurer deferred obligations. (13)

One could easily imagine a taxpayer bailout of Fannie and Freddie driven by the insolvency of the some or all of the six private mortgage insurers that do business with them. Let’s hope that the FHFA addresses that risk now, while the mortgage market is still healthy.

The Homeownership Rate and The Kerner Commission

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photo by Marion S. Trikosko

President Johnson with some members of the National Advisory Commission on Civil Disorders, also known as the Kerner Commission

The Economic Policy Institute released a report, 50 Years After The Kerner Commission.  It finds that “African Americans are better off in many ways but are still disadvantaged by racial inequality.” (1) The report opens,

The year 1968 was a watershed in American history and black America’s ongoing fight for equality. In April of that year, Martin Luther King Jr. was assassinated in Memphis and riots broke out in cities around the country. Rising against this tragedy, the Civil Rights Act of 1968 outlawing housing discrimination was signed into law. Tommie Smith and John Carlos raised their fists in a black power salute as they received their medals at the 1968 Summer Olympics in Mexico City. Arthur Ashe became the first African American to win the U.S. Open singles title, and Shirley Chisholm became the first African American woman elected to the House of Representatives.

The same year, the National Advisory Commission on Civil Disorders, better known as the Kerner Commission, delivered a report to President Johnson examining the causes of civil unrest in African American communities. The report named “white racism”—leading to “pervasive discrimination in employment, education and housing”—as the culprit, and the report’s authors called for a commitment to “the realization of  common opportunities for all within a single [racially undivided] society.” The Kerner Commission report pulled together a comprehensive array of data to assess the specific economic and social inequities confronting African Americans in 1968.

Where do we stand as a society today? In this brief report, we compare the state of black workers and their families in 1968 with the circumstances of their descendants today, 50 years after the Kerner report was released. We find both good news and bad news. While African Americans are in many ways better off in absolute terms than they were in 1968, they are still disadvantaged in important ways relative to whites. In several important respects, African Americans have actually lost ground relative to whites, and, in a few cases, even relative to African Americans in 1968. (1, footnote omitted)

I was particularly shocked by one figure in the report:

One of the most important forms of wealth for working and middle-class families is home equity. Yet, the share of black households that owned their own home remained virtually unchanged between 1968 (41.1 percent) and today (41.2 percent). Over the same period, homeownership for white households increased 5.2 percentage points to 71.1 percent, about 30 percentage points higher than the ownership rate for black households. (4)

It is pretty extraordinary that the homeownership rate for African Americans has not really gone up, given all of the resources that were directed to increasing it. The FHA, Fannie, Freddie and other government programs have all focused on increasing that rate for decades. People of different political stripes will read what they want into this state of affairs. My own take is that wage instability has driven down homeownership rates across the board, but that it has hit African American households particularly hard. Households cannot commit to homeownership if they cannot reasonably depend on getting their wages month-in, month-out.