Author Archives: David Reiss

Fannie & Freddie G-Fee Equilibrium

Posted on by

financial-concept-mortgage

The Federal Housing Finance Agency’s Division of Housing Mission & Goals has issued its report on Fannie Mae and Freddie Mac Single-Family Guarantee Fees in 2015. Guarantee fees (also known as g-fees) are another one of those incredibly technical subjects that actually have a major impact on the housing market. The g-fee is baked into the cost of the mortgage, so the higher the g-fee, the higher the mortgage’s Annual Percentage Rate. Consumer groups and housing trade associations have called upon the FHFA to lower the g-fee to make mortgage credit even cheaper that it is now. This report gives reason to think that the FHFA won’t do that.

The report provides some background on guarantee fees, for the uninitiated:

Guarantee fees are intended to cover the credit risk and other costs that Fannie Mae and Freddie Mac incur when they acquire single-family loans from lenders. Loans are acquired through two methods. A lender may exchange a group of loans for a Fannie Mae or Freddie Mac guaranteed mortgage-backed security (MBS), which may then be sold by the lender into the secondary market to recoup funds to make more loans to borrowers. Alternatively, a lender may deliver loans to an Enterprise in return for a cash payment. Larger lenders tend to exchange loans for MBS, while smaller lenders tend to sell loans for cash and these loans are later bundled by the Enterprises into MBS.

While the private holders of MBS assume market risk (the risk that the price of the security may fall due to changes in interest rates), the Enterprises assume the credit risk on the loans. The Enterprises charge a guarantee fee in exchange for providing this guarantee, which covers administrative costs, projected credit losses from borrower defaults over the life of the loans, and the cost of holding capital to protect against projected credit losses that could occur during stressful macroeconomic conditions. Investors are willing to pay a higher price for Enterprise MBS due to their guarantee of principal and interest. The higher value of the MBS leads to lower interest rates for borrowers.

There are two types of guarantee fees: ongoing and upfront. Ongoing fees are collected each month over the life of a loan. Upfront fees are one-time payments made by lenders upon loan delivery to an Enterprise. Fannie Mae refers to upfront fees as “loan level pricing adjustments,” while Freddie Mac refers to them as “delivery fees.” Both ongoing and upfront fees compensate the Enterprises for the costs of providing the guarantee. Ongoing fees are based primarily on the product type, such as a 30-year fixed rate or a 15-year fixed rate loan. Upfront fees are used to price for specific risk attributes such as the loan-to-value ratio (LTV) and credit score.

Ongoing fees are set by the Enterprises with lenders that exchange loans for MBS, while those fees are embedded in the price offered to lenders that sell loans for cash. In contrast to ongoing fees, the upfront fees are publicly posted on each Enterprise’s website. Upfront fees are paid by the lender at the time of loan delivery to an Enterprise, and those charges are typically rolled into a borrower’s interest rate in the same manner as ongoing fees.

Under the existing protocols of the Enterprises’ conservatorships, FHFA requires that each Enterprise seek FHFA approval for any proposed change in upfront fees. The upfront fees assessed by the two Enterprises generally are in alignment. (2-3)

The report finds that “The average single-family guarantee fee increased by two basis points in 2015 to 59 basis points. This stability is consistent with FHFA’s April 2015 determination that the fees adequately reflected the credit risk of new acquisitions after years of sharp fee increases. During the five year period from 2011 to 2015, fees had more than doubled from 26 basis points to 59 basis points.” (1)

At bottom, your position on the right g-fee level reflects your views about the appropriate role of the government in the housing finance market. If you favor lowering the g-fee, you want to further subsidize homeownership  through cheaper mortgage credit, but you risk a taxpayer bailout.

If you favor raising it, you want to to reduce the government’s footprint in the housing finance market, but you risk rationing credit to those who could use it responsibly.

From this report, it looks like today’s FHFA thinks that it has the balance between those two views in some kind of equilibrium.

The Future of Mortgage Default

Posted on by

photo by Diane BassfordThe Consumer Financial Protection Bureau has shared its Principles for the Future of Loss Mitigation. It opens,

This document outlines four principles, Accessibility, Affordability, Sustainability, and Transparency, that provide a framework for discussion about the future of loss mitigation as the nation moves beyond the housing and economic crisis that began in 2007. As the U.S. Department of Treasury’s Home Affordable Modification Program (HAMP) is phased out, the Consumer Financial Protection Bureau (CFPB) is considering the lessons learned from HAMP while looking forward to the continuing loss mitigation needs of consumers in a post-HAMP world. These principles build on, but are distinct from, the backdrop of the Bureau’s mortgage servicing rules and its supervisory and enforcement authority. This document does not establish binding legal requirements. These principles are intended to complement ongoing discussions among industry, consumer groups and policymakers on the development of loss mitigation programs that span the full spectrum of both home retention options such as forbearance, repayment plans and modifications, and home disposition options such as short sales and deeds-in-lieu.

The future environment of mortgage default is expected to look very different than it did during the crisis. Underwriting based on the ability to repay rule is already resulting in fewer defaults. Mortgage investors have recognized the value of resolving delinquencies early when defaults do occur. Mortgage servicers have developed systems and processes for working with borrowers in default. The CFPB’s mortgage servicing rules have established clear guardrails for early intervention, dual tracking, and customer communication; however, they do not require loss mitigation options beyond those offered by the investor nor do they define every element of loss mitigation execution.

Yet, even with an improved horizon and regulatory guardrails, there is ample opportunity for consumer harm if loss mitigation programs evolve without incorporating key learnings from the crisis. While there is broad agreement within the industry on the high level principles, determining how they translate into programs is more nuanced. Further development of these principles and their implementation is necessary to prevent less desirable consumer outcomes and to ensure the continuance of appropriate consumer protections.

The CFPB concludes,

The CFPB believes these principles are flexible enough to encompass a range of approaches to loss mitigation, recognizing the legitimate interests of consumers, investors and servicers. One of the lessons of HAMP is that loss mitigation that is good for consumers is usually good for investors, as well. The CFPB therefore seeks to engage all stakeholders in a discussion of the principles for future loss mitigation.

I have no beef with this set of principles as far as it goes, but I am concerned that it does not explicitly include a discussion of the role of state court foreclosures in loss mitigation. As this blog has well documented, homeowners are facing Kafkaesque, outrageous, even hellish, behavior by servicers in state foreclosure actions. Even if the federal government cannot address state law issues directly, these issues should be included as part of the discussion of the problems that homeowners face when their mortgages go into default.

Tax Liens and Affordable Housing

Posted on by

paperwork-1054423_1280

NYU’s Furman Center has released a Data Brief, Selling the Debt: Properties Affected by the Sale of New York City Tax Liens. It opens,

When properties in New York City accrue taxes or assessments, those debts become liens against the property. If the debt remains unpaid for long enough, the city is authorized to sell the lien to a third party. In practice, the city retains some liens (because it is legally required to do so in some cases and for strategic reasons in other cases), but it sells many of the liens that are eligible for sale. In this fact brief, we explore the types of properties subject to tax lien sales but exclude Staten Island due to data limitations and exclude condominium units. Between 2010 and 2015, we find that 15,038 individual properties with 43,616 residential units were impacted by the tax lien sale. We answer three questions: (i) what kinds of properties have had a municipal lien sold in recent years? (ii) where are those properties located in the city? (iii) what happens to a property following a lien sale?

We present this information to shine a light on a somewhat obscure process that affects a significant number of properties in the city. Also, the lien sale has a number of policy implications. Tax delinquency can be an indicator of distress; property owners who have not paid their taxes may also cut back on building maintenance and investment. This could have ramifications for owners, tenants, and neighborhoods. The city, social service providers, and practitioners in the community development and housing fields may find this descriptive information helpful as they think about interventions related to the health of housing and neighborhoods.

In addition, the choice of whether to retain a tax lien or to sell the lien also presents a policy choice for the city—selling the lien allows the city to collect needed revenue it is owed; but, with the sale, the city gives up the leverage that it holds over delinquent property owners, which can be used in some cases to move properties into affordable housing programs or meet other strategic goals. The city could retain that leverage by selling fewer liens; but, then it would not only lose the revenue generated by the sale, it would also incur the cost of foreclosing or alternative interventions. The lien sale is part of the city’s municipal debt collection program, and the city must be careful that policy changes do not undermine the city’s debt collection efforts.

With this fact brief, we aim to shed some light on the real world consequences and opportunities triggered by the city’s current treatment of municipal liens. (1-2, footnotes omitted)

New York City has sure come a long way from the 1970s when the City was authorized to foreclose on properties with tax liens. The issue then was that the owners of thousands of buildings did not think it was worth it to pay their taxes. Their preferred strategy was to stop paying their bills and collect rents until the City took their properties away from them. After the City took possession of these buildings, it repurposed many of them into affordable housing projects owned by a range of not-for-profit and for-profit entities.

The Furman brief does not report on why building owners are failing to pay their taxes today. It is reasonable to think that, at least as to multifamily buildings, it is because of operational issues more than because of fundamental problems relating to the profitability of real estate investments in New York City. This is supported by the fact that, when it comes to tax liens, “many if not most debts would be repaid before foreclosure.” (11) Thus, while this brief sheds light on this shadowy corner of the NYC real estate market, it does not seem (as the authors agree) that tax liens will open a path to increasing the stock of affordable housing in the City as it had in the 1980s and 1990s.

What Is an HOA?

Posted on by

photo by Clotee Allochuku

Realtor.com quoted me in What Is an HOA? Homeowners Associations—Explained. It opens,

If you’re buying a condo, townhouse, or freestanding home in a neighborhood with shared common areas—such as a swimming pool, parking garage, or even just the security gates and sidewalks in front of each residence—odds are these areas are maintained by a homeowners association, or HOA.

So what is an HOA, and how will it affect your life?

HOAs help ensure that your community looks its best and functions smoothly, says David Reiss, research director at the Center for Urban Business Entrepreneurship at Brooklyn Law School. For instance, if the pump in the community swimming pool stops working, someone has to take care of it before the water turns green and toxic, right? Rather than expect any one individual in the neighborhood to volunteer their time and money to fix the problem, HOAs are responsible for getting the job done. And the number of Americans living in HOAs is on the rise, growing from a mere 1% in 1970 to 1 in 4 today, according to the Foundation for Community Association Research. So, it’s wise to know exactly how they work.

How much are HOA fees?

To cover these maintenance expenses, HOAs collect fees (monthly or yearly) from all community members. For a typical single-family home, HOA fees will cost homeowners around the $200 to $300 per month, although they can be lower or much higher depending on the size of your unit and the services provided. The larger the home, the higher the HOA fee—which makes sense, because the family of four in a three-bedroom condo is probably going to be using the common facilities more than a single woman living in a studio.

In addition, most HOAs charge their members a little more than monthly expenses require, so that they can build up a reserve to pay for emergencies and big-ticket items like repairing the roof and water heaters, or acquiring new carpeting, paint, and lights for the hallways.

If the HOA doesn’t have enough money in reserve to cover necessary expenses, it can issue a special “assessment,” or an extra fee, in addition to your monthly dues, so that the repairs can be made. For example, if the elevator in your condo building goes out and it’s going to cost $15,000 to replace it—but the HOA reserve account holds only $12,000—you and the rest of the residents are going to have to pony up at least an additional $3,000, divided among you, to make up the difference.

And yes, you would still have to contribute your share even if you live on the first floor.

HOA rules: What to expect

All HOAs have boards, made up of homeowners in the complex who are typically elected by all homeowners. These board members will set up regular meetings where owners can gather and discuss major decisions and issues with their community. For major expenditures, all members of the HOA usually vote.

In addition to maintaining the common areas, HOAs are also responsible for seeing that its community members follow certain rules. Homeowners receive a copy of these rules, knowns as “covenants, conditions, and restrictions” (CC&Rs), when they move in, and they’re required to sign a contract saying that they’ll abide by them.

CC&Rs can cover everything from your type of mailbox to the size and breed of your dog. Some HOAs require you to purchase extra homeowners insurance if you own a pit bull, for example; others prohibit certain breeds entirely. An HOA may even regulate what color you paint your house, and what kind of curtains you can hang if your unit faces the street. Its goal is not to meddle—it’s merely to maintain a neighborhood aesthetic. However, if you don’t like being told what to do with your home, an HOA may not be for you.

Another Housing Bubble?

Posted on by

bubble-500130_1280

Trulia quoted me in Warning Signs: Another Housing Bubble Is Coming. It opens,

Signs show another bubble coming. Some experts have a different opinion.

When the housing market crashed in 2008, it caused what came to be known as ”The Great Recession.” When the bubble burst, it ”sent a shock through the entire financial system, increasing the perceived credit risk throughout the economy,” according to a report published in The Journal of Business Inquiry.

The crash caused homes to lose up to half their value. People became underwater, owing more than their home was worth. And who wants to pay on a mortgage that’s larger than what the home could sell for? Although some people did just that, many more opted to short sell their homes or to simply walk away and have the bank foreclose.

Present Day

Fast-forward to 2016, and we are seeing hot, even ” overheated,” housing markets; bidding wars; rising home prices; and house flippers – all the signs of a housing bubble that’s about to burst. Are we repeating the mistakes we made before? Yes and no. Let’s explore four reasons the housing bubble burst and whether we’re experiencing the same conditions today.

1. Easy Credit

Before the 2008 crash, credit was easy to get. Pretty much, if you were breathing, you could get a mortgage loan. This led to people getting mortgages who ultimately couldn’t afford to pay them back. They lost their homes, and this contributed in large part to the housing crisis. Today the situation is different. ”Credit is still much tighter than it was before the financial crisis,” says David Reiss, professor of law at Brooklyn Law School. ”This is particularly true for those with less-than-perfect credit scores.” He explains: ”There are almost no no-down-payment loans as there were in the early 2000s. Those defaulted at incredibly high rates.”

But what about Federal Housing Administration (FHA) loans? They feature ”low down payments, low closing costs, and easy credit qualifying.” Those are the very features that should sound some warning bells. But before you get too alarmed, keep in mind that the FHA has been making loans to people who do not qualify for a conventional mortgage since 1934. ”While there are low-down-payment loans available from Fannie, Freddie, and the FHA, their underwriting standards appear to be higher than those for low-down-payment products from the early 2000s,” says Reiss.

2. Low Interest Rates

Mortgage rates have been low for so long that you might not realize that was not always the case. In 1982, for example, mortgage rates were 18 percent. From 2002 to 2005, the rates stayed at about 6 percent, which enticed people to take out mortgage loans. And in 2016, we’re seeing historic lows of under 3.5 percent. If rates go up, we might see housing demand and housing prices fall.

3. ARMS

Before the housing crash when home prices were rising fast, many people were priced out of the market with a fixed-rate mortgage because they couldn’t afford the monthly mortgage payments. But they could afford lower payments that were possible with an adjustable-rate mortgage – until that rate adjusted up. In 2005, 38.5 percent of the mortgage market was ARMs. But in 2015, that amount has dropped considerably to 5.3 percent.

4. A Buying Frenzy

There’s an old story that before the stock market crash of 1929, Joseph Kennedy, Sr., sold his shares. Why? Because he received a stock tip from a shoeshine boy. Kennedy figured, the story goes, that if the stock market was popular enough for a shoeshine boy to be interested, the speculative bubble had become too big.

Before the housing crash, this country saw a home buying frenzy similar to what happened before the stock market crash. Everyone from lenders to rating agencies to investors (foreign and American) to investment bankers to home buyers was eager to get into the mortgage game because house values kept rising. Today, we are seeing a similar buying frenzy in some markets, such as San Francisco, New York, and Miami . Some experts think that the price increases of homes in those areas are not sustainable. They say that because heavy foreign investment in those areas is part of what’s driving up prices, if those investments slow or stop, we could see a bubble burst.

So what do some experts think?

David Ranish, owner/broker for The Coastline Real Estate Group in Laguna Beach, CA, says: ”There are concerns about another housing bubble, but I do not see it. The market could stabilize, but a complete collapse is highly unlikely.”

Bruce Ailion, an Atlanta, GA, real estate expert, says,” ”Five to six years ago, I was a buyer of homes. Today I am a seller.”

David Reiss says, ”It is probably a fool’s game to predict the future of the housing market or whether we are in a bubble that is soon to burst.”

Freddie and Fannie Nightmare Scenario

Posted on by

male and female zombies

For a number of years, I have warned of the increased operational risk that results from leaving Fannie Mae and Freddie Mac in the limbo of their conservatorships. “Operational risk” refers to risks that a company faces from things like poor procedures, systems, policies and employee supervision.

The Inspector General of the Federal Housing Finance Agency has released three reports that address aspects of Fannie and Freddie’s operational risk (along with that of the Federal Home Loan Bank System). The three reports are:

The last of the three reports notes,

As the regulator of Fannie Mae and Freddie Mac (collectively, the Enterprises) and of the Federal Home Loan Banks (FHLBanks), the Federal Housing Finance Agency (FHFA) is tasked by statute to ensure that these entities operate safely and soundly so that they serve as a reliable source of liquidity and funding for housing finance and community investment. Examinations of its regulated entities are fundamental to FHFA’s supervisory mission.

FHFA has directed its Division of Enterprise Regulation (DER) to conduct supervisory activities of the Enterprises and its Division of Federal Home Loan Bank Regulation (DBR) to conduct these activities for the FHLBanks. When DER or DBR identifies a deficiency, it will classify the deficiency as a Matter Requiring Attention (MRA), a violation, or a recommendation. According to FHFA, MRAs are “the most serious supervisory matters.” FHFA requires the regulated entities to promptly remediate MRAs. Examiners are required to “check and document” the progress of MRA remediation.

In FHFA Office of Inspector General’s (OIG) 2016 Audit and Evaluation Plan, we explained our intent to focus our resources on programs and operations that pose the greatest financial, governance, and reputational risk to FHFA, the Enterprises, and the FHLBanks. One of the four areas we identified was FHFA’s rigor in its supervision of the Enterprises and the FHLBanks. According to FHFA, a key component of effective supervision is close oversight of efforts by an entity it regulates to correct identified supervisory concerns. This evaluation is one in a series of OIG reports that assess the robustness of FHFA’s policies, procedures, and practices governing its oversight of remediation of supervisory concerns by a regulated entity.

In this evaluation, we compared the MRA tracking systems used by two federal financial regulators and DBR to those used by the DER Fannie Mae and Freddie Mac examination teams. We found substantial weaknesses in DER’s tracking systems that limit significantly the utility of those systems as a tool to monitor the Enterprises’ efforts to remediate deficiencies giving rise to MRAs. We also reviewed a sample of open and closed MRAs issued to each Enterprise by DER to assess whether DER examiners performed independent assessments of the timeliness and adequacy of each Enterprise’s efforts to remediate the MRA. Our review found a lack of consistent independent analysis by DER examiners of the timeliness and adequacy of each Enterprise’s remedial efforts. (2)

My nightmare scenario is that Fannie and Freddie operations have slowly degraded as they have been left to linger in the limbo of conservatorship. This kind of degradation is not really observable from the outside and its effects are not known until something really bad happens. Maybe their hedging strategy is poorly designed, maybe their underwriting is allowed to become outdated, maybe too many employees lose their drive.

Eight years of conservatorship can do that to a company. When it happens, you can be sure that members of Congress will blame a whole host of people for this failure. But the blame will sit with Congress. Because Democrats and Republicans cannot come up with a reasonable compromise, we are left with two zombie organizations dominating our housing finance system.

Hopefully, I am wrong about this. Or maybe I am right about it but we dodge the bullet by some stroke of luck. But the longer we leave the two companies in this state, the more likely it is that things go bad and the taxpayer is left holding the bag once again.

 

Regulating Small Lenders

Posted on by

photo by Doug Kerr

The Consumer Financial Protection Bureau is often subject to a lot of criticism for imposing a heavy regulatory burden on small community banks and credit unions (together, community lenders). A recent Government Accountability Office report, Community Lenders Remain Active under New Rules, but CFPB Needs More Complete Plans for Reviewing Rules, undermines that critique.

The GAO did this report at the request of Representative Hensarling (R-TX), the Financial Services Committee Chair, who sought to understand the impact of various rules promulgated under Dodd-Frank on community lenders and their customers. The report studied the impact of mortgage servicing and regulatory capital rules on community lenders’ participation in the mortgage servicing market. (Mortgage servicing refers to the business of receiving monthly mortgage payments and providing other services relating to outstanding mortgages on behalf of the owner of the mortgage, which in some cases may also be the servicer itself).

The GAO found that community lenders “remained active in servicing mortgage loans under the” CFPB’s new mortgage-servicing rules. (n.p., front matter)

The report also described the small lender business model in some detail. Servicing activities

generated income and allowed them to maintain strong relationships with their customers. Some of these community lenders and industry associations noted that holding mortgage loans in portfolio and servicing these mortgage loans helped with overall profitability. For example, the servicing revenue can offset a reduction in income from originating loans when interest rates rise. Conversely, when interest rates decline, borrowers are more likely to prepay or refinance their mortgage loans, and servicing revenue may decline, while income from new mortgage loan originations might increase. (15)

Community lenders also claimed that ” they and their customers benefit from the close relationship maintained when these institutions service mortgages. . . . For example, representatives at one community bank told us that a customer who could not make a mortgage payment could meet directly with a bank representative to develop a payment plan.”  (16)

We often romanticize the small lenders (think, Bailey Brothers’ Building and Loan) and demonize the big banks (think, The Big Short). This report shows that the little guy is doing okay under Dodd-Frank, at least when it comes to servicing. It remains to be seen whether borrowers in the aggregate are better off with small lenders and their personal touch, but we will leave that discussion for another day.