Easy Money From Fannie Mae

The San Francisco Chronicle quoted me in Fannie Mae Making It Easier to Spend Half Your Income on Debt. It reads in part,

Fannie Mae is making it easier for some borrowers to spend up to half of their monthly pretax income on mortgage and other debt payments. But just because they can doesn’t mean they should.

“Generally, it’s a pretty poor idea,” said Holly Gillian Kindel, an adviser with Mosaic Financial Partners. “It flies in the face of common financial wisdom and best practices.”

Fannie is a government agency that can buy or insure mortgages that meet its underwriting criteria. Effective July 29, its automated underwriting software will approve loans with debt-to-income ratios as high as 50 percent without “additional compensating factors.” The current limit is 45 percent.

Fannie has been approving borrowers with ratios between 45 and 50 percent if they had compensating factors, such as a down payment of least 20 percent and at least 12 months worth of “reserves” in bank and investment accounts. Its updated software will not require those compensating factors.

Fannie made the decision after analyzing many years of payment history on loans between 45 and 50 percent. It said the change will increase the percentage of loans it approves, but it would not say by how much.

That doesn’t mean every Fannie-backed loan can go up 50 percent. Borrowers still must have the right combination of loan-to-value ratio, credit history, reserves and other factors. In a statement, Fannie said the change is “consistent with our commitment to sustainable homeownership and with the safe and sound operation of our business.”

Before the mortgage meltdown, Fannie was approving loans with even higher debt ratios. But 50 percent of pretax income is still a lot to spend on housing and other debt.

The U.S. Census Bureau says households that spend at least 30 percent of their income on housing are “cost-burdened” and those that spend 50 percent or more are “severely cost burdened.”

The Dodd-Frank Act, designed to prevent another financial crisis, authorized the creation of a “qualified mortgage.” These mortgages can’t have certain risky features, such as interest-only payments, terms longer than 30 years or debt-to-income ratios higher than 43 percent. The Consumer Financial Protection Bureau said a 43 percent limit would “protect consumers” and “generally safeguard affordability.”

However, loans that are eligible for purchase by Fannie Mae and other government agencies are deemed qualified mortgages, even if they allow ratios higher than 43 percent. Freddie Mac, Fannie’s smaller sibling, has been backing loans with ratios up to 50 percent without compensating factors since 2011. The Federal Housing Administration approves loans with ratios up to 57 percent, said Ed Pinto of the American Enterprise Institute Center on Housing Risk.

Since 2014, lenders that make qualified mortgages can’t be sued if they go bad, so most lenders have essentially stopped making non-qualified mortgages.

Lenders are reluctant to make jumbo loans with ratios higher than 43 percent because they would not get the legal protection afforded qualified mortgages. Jumbos are loans that are too big to be purchased by Fannie and Freddie. Their limit in most parts of the Bay Area is $636,150 for one-unit homes.

Fannie’s move comes at a time when consumer debt is soaring. Credit card debt surpassed $1 trillion in December for the first time since the recession and now stands behind auto loans ($1.1 trillion) and student loans ($1.4 trillion), according to the Federal Reserve.

That’s making it harder for people to get or refinance a mortgage. In April, Fannie announced three small steps it was taking to make it easier for people with education loans to get a mortgage.

Some consumer groups are happy to see Fannie raising its debt limit to 50 percent. “I think there are enough other standards built into the Fannie Mae underwriting system where this is not going to lead to predatory loans,” said Geoff Walsh, a staff attorney with the National Consumer Law Center.

Mike Calhoun, president of the Center for Responsible Lending, said, “There are households that can afford these loans, including moderate-income households.” When they are carefully underwritten and fully documented “they can perform at that level.” He pointed out that a lot of tenants are managing to pay at least 50 percent of income on rent.

A new study from the Joint Center for Housing Studies at Harvard University noted that 10 percent of homeowners and 25.5 percent of renters are spending at least 50 percent of their income on housing.

When Fannie calculates debt-to-income ratios, it starts with the monthly payment on the new loan (including principal, interest, property tax, homeowners association dues, homeowners insurance and private mortgage insurance). Then it adds the monthly payment on credit cards (minimum payment due), auto, student and other loans and alimony.

It divides this total debt by total monthly income. It will consider a wide range of income that is stable and verifiable including wages, bonuses, commissions, pensions, investments, alimony, disability, unemployment and public assistance.

Fannie figures a creditworthy borrower with $10,000 in monthly income could spend up to $5,000 on mortgage and debt payments. Not everyone agrees.

“If you have a debt ratio that high, the last thing you should be doing is buying a house. You are stretching yourself way too thin,” said Greg McBride, chief financial analyst with Bankrate.com.

*     *     *

“If this is data-driven as Fannie says, I guess it’s OK,” said David Reiss, who teaches real estate finance at Brooklyn Law School. “People can make decisions themselves. We have these rules for the median person. A lot of immigrant families have no problem spending 60 or 70 percent (of income) on housing. They have cousins living there, they rent out a room.”

Reiss added that homeownership rates are low and expanding them “seems reasonable.” But making credit looser “will probably drive up housing prices.”

The article condensed my comments, but they do reflect the fact that the credit box is too tight and that there is room to loosen it up a bit. The Qualified Mortgage and Ability-to-Repay rules promote the 43% debt-to-income ratio because they provide good guidance for “traditional” nuclear American families.  But there are American households where multigenerational living is the norm, as is the case with many families of recent immigrants. These households may have income streams which are not reflected in the mortgage application.

GSE Investors’ Hidden Win

Judge Brown

The big news yesterday was that the US Court of Appeals for the DC Circuit ruled in the main for the federal government in Perry Capital v. Mnuchin, one of the major cases that investors brought against the federal government over the terms of the Fannie and Freddie conservatorships.

In a measured and carefully reasoned opinion, the court rejected most but not all of the investors’ claims.  The reasoning was consistent with my own reading of the broad conservatorship provisions of the Housing and Economic Recover Act of 2008 (HERA).

Judge Brown’s dissent, however, reveals that the investors have crafted an alternative narrative that at least one judge finds compelling. This means that there is going to be some serious drama when this case ultimately wends its way to the Supreme Court. And there is some reason to believe that a Justice Gorsuch might be sympathetic to this narrative of government overreach.

Judge Brown’s opinion indicts many aspects of federal housing finance policy, broadly condemning it in the opening paragraph:

One critic has called it “wrecking-ball benevolence,” James Bovard, Editorial, Nothing Down: The Bush Administration’s Wrecking-Ball Benevolence, BARRONS, Aug. 23, 2004, http://tinyurl.com/Barrons-Bovard; while another, dismissing the compassionate rhetoric, dubs it “crony capitalism,” Gerald P. O’Driscoll, Jr., Commentary, Fannie/Freddie Bailout Baloney, CATO INST., http://tinyurl.com/Cato-O-Driscoll (last visited Feb. 13, 2017). But whether the road was paved with good intentions or greased by greed and indifference, affordable housing turned out to be the path to perdition for the U.S. mortgage market. And, because of the dominance of two so-called Government Sponsored Entities (“GSE”s)—the Federal National Mortgage Association (“Fannie Mae” or “Fannie”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac” or “Freddie,” collectively with Fannie Mae, the “Companies”)—the trouble that began in the subprime mortgage market metastasized until it began to affect most debt markets, both domestic and international. (dissent at 1)

While acknowledging that the Fannie/Freddie crisis might justify “extraordinary actions by Congress,” Judge Brown states that

even in a time of exigency, a nation governed by the rule of law cannot transfer broad and unreviewable power to a government entity to do whatsoever it wishes with the assets of these Companies. Moreover, to remain within constitutional parameters, even a less-sweeping delegation of authority would require an explicit and comprehensive framework. See Whitman v. Am. Trucking Ass’ns, Inc., 531 U.S. 457, 468 (2001) (“Congress . . . does not alter the fundamental details of a regulatory scheme in vague terms or ancillary provisions—it does not, one might say, hide elephants in mouseholes.”) Here, Congress did not endow FHFA with unlimited authority to pursue its own ends; rather, it seized upon the statutory text that had governed the FDIC for decades and adapted it ever so slightly to confront the new challenge posed by Fannie and Freddie.

*     *     *

[Congress] chose a well-understood and clearly-defined statutory framework—one that drew upon the common law to clearly delineate the outer boundaries of the Agency’s conservator or, alternatively, receiver powers. FHFA pole vaulted over those boundaries, disregarding the plain text of its authorizing statute and engaging in ultra vires conduct. Even now, FHFA continues to insist its authority is entirely without limit and argues for a complete ouster of federal courts’ power to grant injunctive relief to redress any action it takes while purporting to serve in the conservator role. See FHFA Br. 21  (2-3)

What amazes me about this dissent is how it adopts the decidedly non-mainstream history of the financial crisis that has been promoted by the American Enterprise Institute’s Peter Wallison.  It also takes its legislative history from an unpublished Cato Institute paper by Vice-President Pence’s newly selected chief economist, Mark Calabria and a co-author.  There is nothing wrong with a judge giving some context to an opinion, but it is of note when it seems as one-sided as this. The bottom line though is that this narrative clearly has some legs so we should not think that this case has played itself out, just because of this decision.

Thursday’s Advocacy & Think Tank Round-Up

Seismic Shift in Lending?

Researchers at the American Enterprise Institute’s International Center on Housing Risk have posted a study that shows a “seismic shift in lending away from large banks to nonbanks.” (1) The key takeaways are

  • The dramatic decline in agency market share for large banks continued unabated in February, offset by an equally dramatic increase in the nonbank share.
  • Since November 2012, the large bank share has dropped from 61% to 33%, a move of 28 points, including a 1.2 point drop in February, a dramatic decline that has been met point-for-point by a 27 point increase in the nonbank share from 24% to 51%. Large nonbanks and other nonbanks have participated equally in the increase, accounting for 14 points and 13 points respectively.
  • Large banks have reduced the riskiness of their agency mortgage originations over the past few years. Nonbanks, in contrast, have shifted toward riskier loans as they have increased their market share.
  • Loans originated through the retail channel are less risky than loans originated through the broker and correspondent channels. This is true both for large banks and for nonbanks. But retail channel loans from nonbanks are substantially riskier than such loans from large banks.
  • The bottom line is that large banks attempting to regain market share would have to move well out the risk curve. (1)

While these findings are presented as negative developments, it is unclear to me that they are. Market share among big players in the mortgage market does vary dramatically over time. Given the new regulatory environment imposed by Dodd Frank, it is not surprising that the industry would readjust in some ways and that specialized nonbanks might increase market share once the financial crisis subsided. It is also unclear that moving out the risk curve is bad in today’s environment. Today’s lenders are quite conservative compared to the pre-crisis ones and there is good reason to think that lenders could safely loosen their underwriting somewhat. This is not to say, of course, that they should return to the bad old days. Just that there are more creditworthy borrowers out there.

Reiss on Marketplace: Cash Cows to Slaughter

I was interviewed on Marketplace for its story, Fannie and Freddie: Cash Cows Avoid The Slaughter? (sound file) The text of the story reads

We are making money – the tax payer, that is – on Fannie and Freddie Mac.

When Freddie Mac hands the treasury a $10.4 billion dividend next month, tax payers will have received more money in interest than was put in. (Technically the two institutions still owe the principal on the loan that bailed them out, but the interest they’re paying will shortly exceed that amount).

But.

There always is a but with these things.

Making money for the tax payer isn’t good if you ask those who want reform.

Back during the financial crisis, conservatives and liberals disagreed over whether Freddie and Fannie were a victim of or a cause of the housing collapse, but they agreed that the institutions needed reform. The profits are throwing a wrinkle into this debate.

“As long as Fannie and Freddie continue to pay substantial amounts of money to the government, they are looked at by some people in Congress as a great source of revenue that reduces the deficit,” explains Peter Wallison with the American Enterprise Institute. His concern – shared by reformers on both sides of the political spectrum – is that if Fannie and Freddie become cash cows, congress won’t want to touch them.

David Reiss, professor of law at the Brooklyn Law School, agrees. He says the financial crisis wasn’t a one time problem.

“We should think of it as that we dodged a bullet. There’s fundamental problems with the Fannie and Freddie business model which rests on this notion of privatizing profits and socializing losses.”

Freddie and Fannie buy mortgages from lenders, and then bundle them into “mortgage backed securities” that can be sold to investors. It’s useful because it converted illiquid mortgage loans into liquid securities. In plain English, it means a bank or investor who made a mortgage loan to someone didn’t have to wait around for 30 years to be paid back. They could sell their stake in the mortgage to Fannie or Freddie, move along, and go invest in other things. This helped more people get mortgages.

One concern was that Fannie and Freddie were simply too big and too concentrated. Another concern was that the federal government implicitly guaranteed investments in Freddie and Fannie, and that encouraged people to make home loans that were too risky.

Even without the complication of profits, the debate over how to reform Fannie and Freddie is at a stand still.

House Republicans don’t want the government involved at all, they want an efficient market. The Senate wants the government to be involved a little bit, essentially to promote housing.

“What I see,” says David Reiss, “is nothing really happening, and us being a holding pattern for a long time.”

It’s possible that reform-minded politicians will compromise before they lose their chance. Also possible they won’t.

Lifting a Shadow from Qualified Residential Mortgages

The self-named Shadow Financial Regulatory Committee of the American Enterprise Institute has issued a statement on The New Qualified Residential Mortgage Rule Proposal.  The Shadow Committee argues that agencies promulgating the newest version of the QRM rule

completely abandoned the Act’s requirement for a separate high-quality QRM. Instead, they proposed a QRM that was essentially the equivalent of the QM. This not only violated the congressional intent and nullified the retainage, but it pushed the US mortgage system back toward the very policies that fed the housing bubble, the mortgage meltdown and the financial crisis. It responds to those want the mortgage finance system to make mortgage credit widely available, but it ignores the need for a stable system that will avoid a future crisis. (2)

This is not fully accurate. The QRM proposal does not violate congressional intent because Congress merely stated that the QRM be “no broader” than the QM. (Dodd-Frank Act Section 941) There is also a fair amount of fear-mongering here because the Shadow Committee does not propose how we can responsibly balance credit availability with systemic stability.

Nonetheless, the Shadow Committee is right to note that the rules governing mortgages must balance a number of competing goals.
When the proposed rule was released, I had written that it should incorporate a “benefit ratio” which

compares “the percent reduction in the number of defaults to the percent reduction in the number of borrowers who would have access to QRM mortgages.” (20) A metric of this sort would go a long way to ensuring that there is transparency for homeowners as to the likelihood that they can not only get a mortgage but also pay it off and keep their homes.

A benefit ratio would not only help ensure that homeowners received sustainable mortgages, but it would also address the systemic concerns raised by the Shadow Committee. This is because the benefit ratio would protect lenders from their own worse instincts as they lower their underwriting standards in pursuit of increased market share in a booming market.