Author Archives: David Reiss

Retail Trading Comes to Mortgage-Backed Securities

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In a recent paper, Bessembinder et al. look at the implications of FINRA’s proposal to disseminate trade prices for structured products like mortgage-backed securities to the public.  They evaluate how price transparency has impacted the corporate bond market and find that it “increased bonds’ propensity to trade and increased overall volume.”  (24)  They note that trading costs shrank.  They argue that the same impact may be felt in structured product markets.

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It is unclear what this change will mean for the homeowner, but it would seem to mean that there will be a reduction in interest expense and an increase in liquidity in the market for credit but perhaps also an increase in the role that “animal spirits” will play as the business cycle inexorably turns from bust to plateau to boom to bust . . ..

Opposition to FHFA Increase in Guaranty Fees for States with Lengthy Foreclosures

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Senators from the five affected states have written a letter to the FHFA’s DeMarco.  This debate presents a choice between risk-based pricing on the one hand and what is generally considered a pro-homeowner legal regime on the other.

The FHFA’s notice is here.

NY AG Sues Credit Suisse over Bad Due Diligence

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The complaint is here.  The allegations are similar to those that the NY AG made against JPMorgan.

New Affordable Housing Goals Set for Fannie and Freddie

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The FHFA issued a final rule.  The summary is as follows:

The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (Safety and Soundness Act) requires the Federal Housing Finance Agency (FHFA) to establish annual housing goals for mortgages purchased by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) (collectively, the Enterprises). FHFA previously established housing goals for the Enterprises through 2011. This final rule establishes new levels for the housing goals for 2012 through 2014, consistent with the requirements of the Safety and Soundness Act.

The new goal levels are lower than those from the last couple of years.  For a taste of the controversy surrounding affordable housing goals see this, this and this on the one hand and see this, this and this on the other.  My own take is that Wallison and Pinto make broad claims about the negative effects of affordable housing goals that attach big effects to long ago events.  Their claims have not been supported empirically and have not gone through a peer review process.  That being said, I think it is valuable to draw attention to the unintended effects of government policies.  Going forward, Congress and the FHFA should be very careful in their program design to ensure that housing policies have their desired effects — no more, no less.

Disturbing Reminders about Rating Agencies in Brummer’s New Article

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Some disturbing reminders in The New Politics of Transatlantic Credit Rating Agency Regulation.  Major rating agencies (CRAs)

generally did not verify the information used to determine the creditworthiness of the products they rated. Plus new models for rating subprime mortgages assumed that housing prices would continue to increase and the model did not consider the declining quality of the loans themselves. And even where signs did begin to arise, bonds were rated at specific intervals, and not necessarily in reaction to crisis, effectively preserving the long life of artificially inflated ratings. By giving MBS and CDOs high ratings, CRAs essentially encouraged investment in these products. The impact: “Of all mortgage-backed securities it had rated triple-A in 2006, Moody’s downgraded 73% to junk”. Similarly, 80% of CDOs rated AAA by S&P from 2005-2007 were downgraded below investment grade by 2009. Well over a third ended up defaulting, wrecking havoc on the financial system and causing the downfall of scores of financial institutions, including behemoths AIG and Lehman Brothers.  (13-14, citations omitted)

 

“Downgrading Rating Agency Reform”

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This is the title of Jeffrey Mann’s forthcoming article.  He writes

The most important part of the Act remains the most unresolved: the SEC’s mandate to design an alternative rating industry    business model to address the conflicts of interest created by debt issuers’ selecting and paying their rating agency gatekeepers.  Prospects for the creation of an independent commission to select rating agencies for structured finance products have foundered due to the challenges of crafting benchmarks for rating agency performance to use in selecting rating agencies and holding them accountable. The use of any performance-based standard to select or evaluate rating agencies risks fueling herding effects as rating agencies may shape their methodologies to game the system rather than to enhance accurate and timely assessments of credit risk.  (page 5, emphasis added, footnotes omitted)

How to regulate the rating of structured finance products remains the key issue in rating agency reform.  It is a much knottier issue than the rating of corporate or municipal debt because rating agencies have historically played a key role in designing these securities so that a given pool was rated investment grade to the greatest extent possible.

FHA 2012 Annual Report on MMIF Shows Great Stress on Agency

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The report‘s findings show that the academic critics (here and here) of the FHA’s risk analysis were on to something over the last couple of years.