De Facto Housing Finance Reform

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)

Treasury’s Take on Housing Finance Reform

Treasury Secretary Mnuchin Being Sworn In

The Department of the Treasury released its Strategic Plan for 2018-2022. One of its 17 Strategic Objectives is to promote housing finance reform:

Support housing finance reform to resolve Government-Sponsored Enterprise (GSE) conservatorships and prevent taxpayer bailouts of public and private mortgage finance entities, while promoting consumer choice within the mortgage market.

Desired Outcomes

Increased share of mortgage credit supported by private capital; Resolution of GSE conservatorships; Appropriate level of sustainable homeownership.

Why Does This Matter?

Fannie Mae and Freddie Mac have been in federal conservatorship for nine years. Taxpayers continue to stand behind their obligations through capital support agreements while there is no clear path for the resolution of their conservatorship. The GSEs, combined with federal housing programs such as those at the Federal Housing Administration and the Department of Veterans Affairs, support more than 70 percent of new mortgage originations. Changes should encourage the entry of greater private capital in the U.S. housing finance system. Resolution of the GSE conservatorships and right-sizing of federal housing programs is necessary to support a more sustainable U.S. housing finance system. (16)

The Plan states that Treasury’s strategies to achieve these objectives are to engage “stakeholders to develop housing finance reform recommendations.” (17) These stakeholders include Congress, the FHFA, Fed, SEC, CFPB, FDIC, HUD (including the FHA), VA, Fannie Mae, Freddie Mac, the Association of State Banking Regulators as well as “The Public.” Treasury further intends to disseminate “principles and recommendations for housing finance reform” and plan “for the resolution of current GSE conservatorships.” (Id.)

This is all to the good of course, but it is at such a high level of generality that it tells us next to nothing. In this regard, Trump’s Treasury is not all that different from Obama and George W. Bush’s. Treasury has not taken a lead on housing finance reform since the financial crisis began. While there is nothing wrong with letting Congress take the lead on this issue, it would move things forward if Treasury created an environment in which housing finance reform was clearly identified as a priority in Washington. Nothing good will come from letting Fannie and Freddie limp along in conservatorship for a decade or more.

Buying after Bankruptcy

Realtor.com quoted me in Buying a House After Bankruptcy? How Long to Wait and What to Do. It opens,

Buying a house after bankruptcy may sound like an impossible feat. Blame it on all those Monopoly games, but bankruptcy has a very bad rap, painting the filer as someone who should never be loaned money. The reality is that of the 800,000 Americans who file for bankruptcy every year, most are well-intentioned, responsible people to whom life threw a curveball that made them struggle to pay off past debts.

Sometimes filing for bankruptcy is the only way out of a crushing financial situation, and taking this step can really help these cash-strapped individuals get back on their feet. And yes, many go on to eventually buy a home. Only how?

Being aware of what a lender expects post-bankruptcy will help you navigate the mortgage application process efficiently and effectively. Here are the steps on buying a house after bankruptcy, and the top things you need to know.

Types of bankruptcy: The best and the worst

There are two ways to file for bankruptcy: Chapter 7 and Chapter 13. With Chapter 7, filers are typically released from their obligation to pay back unsecured debt—think credit cards, medical bills, or loans extended without collateral. Chapter 13 filers have to pay back their debt, only it’s reorganized to come up with a new repayment schedule that makes monthly payments more affordable.

Since Chapter 13 filers are still paying back their debts, mortgage lenders generally look more favorably on these consumers than those who file for Chapter 7, says David Carey, vice president and residential lending manager at New York’s Tompkins Mahopac Bank.

How long after bankruptcy should you wait before buying a house?

Most people applying for a loan will need to wait two years after bankruptcy before lenders will consider their application. That said, it could be up to a four-year ban, depending on the individual and type of loan. This is because lenders have different “seasoning” requirements, which is a specified amount of time that needs to pass.

Fannie Mae, for example, has a minimum two-year ban on borrowers who have filed for bankruptcy, says David Reiss, professor of law and academic programs director at the Center for Urban Business Entrepreneurship at Brooklyn Law School. The FHA, on the other hand, has a minimum one-year ban in place after a bankruptcy. The time is measured starting from the date of discharge or dismissal of the bankruptcy action. Generally the more time that passes, the less risky a once-bankrupt borrower looks in the eyes of a lender.

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.

Fox in The CRA Henhouse

Law360 quoted me in Treasury’s Fair Lending Review Worries Advocates (behind a paywall). It reads, in part,

President Donald Trump’s Treasury Department said Monday that revisiting a 1977 law aimed at boosting bank lending and branches in poor neighborhoods was a “high priority,” but backers of the Community Reinvestment Act fear that any move by this administration would be aimed at weakening, not modernizing, the law.

Critics and some backers of the Community Reinvestment Act say that the law does not take into account mobile banking and the decline of branch networks among a host of other updates needed to meet the realities of banking in 2017.

While there is some agreement on policy, the politics of reworking the CRA are always difficult. Those politics will be even more difficult with the Trump administration and Treasury Secretary Steven Mnuchin, who ran into problems with the CRA when he was the chairman of OneWest Bank, leading the review, said David Reiss, a professor at Brooklyn Law School.

“A team at Treasury led by the OneWest leadership should give consumer advocates pause,” he said.

*   *   *

Across the administration, from the U.S. Department of Education to the Department of Justice, civil rights enforcement has taken a back seat to other concerns. And Mnuchin is in the process of populating the Treasury Department with former colleagues from OneWest.

Trump nominated former OneWest CEO Joseph Otting to be comptroller of the currency earlier this month and is reportedly close to nominating former OneWest Vice Chairman and Chief Legal Officer Brian Brooks as deputy Treasury secretary. Brooks is currently the general counsel at Fannie Mae.

Activists who fought the CIT-OneWest merger on CRA grounds say that the placement of those former OneWest executives in positions of authority over the law should raise alarms.

“[Mnuchin’s] bank, OneWest, also had one of the worst community reinvestment records of all the banks that CRC analyzes in California, which raises questions about his motivation in ‘reforming’ the Community Reinvestment Act. Is he interested in reforming it to help communities, or to help the industry do even less?” said Paulina Gonzalez of the California Reinvestment Coalition.

The Treasury secretary has defended his bank’s foreclosure practices and others that drew fair lending advocates’ ire, saying that most of the problems at OneWest were holdovers from IndyMac, the failed subprime lender OneWest’s investors purchased after it failed.

Discussing reforms to the CRA under any administration, particularly a typical Republican administration, would be difficult on its own for lawmakers and inside regulatory agencies, Schaberg said.

“Anybody down in the middle-management tier of any of the banking agencies, they’re not going to touch this because it’s so politically charged,” he said.

The added distrust of the Trump administration and Mnuchin among fair housing advocates makes the prospect of any legislation to reshape even harder to imagine. Even without legislation, new leadership at the regulatory agencies that monitor for CRA compliance could take a lighter touch. And that has fair housing backers on edge.

“In my mind, there’s a fox-in-the-henhouse mentality,” Reiss said.

Framing Bipartisan Housing Finance Reform

photo by Jan Tik

The Bipartisan Policy Center has issued A Framework for Improving Access and Affordability in a Reformed Housing Finance System. The brief was written by Michael Stegman who had served as the Obama Administration’s top advisor on housing policy. It opens,

With policymakers gearing up to reform the housing finance system, it is worth revisiting one of the issues that stymied negotiators in the reform effort of 2014: how to ensure adequate access to credit in the new system. The political landscape has changed substantially since 2014. For those who are focused on financing affordable housing and promoting access to mortgage credit, the status quo—the continued conservatorship of Fannie Mae and Freddie Mac—may no longer be as appealing as it was during those negotiations. This brief draws upon the lessons learned from that experience to outline a framework for bipartisan consensus in this transformed political environment.

The “middle-way” approach described here is not dependent upon any one structure or future role for the government-sponsored enterprises (GSEs), though it does assume the continuation of a government guarantee of qualified mortgage-backed securities (MBS). It is this guarantee that forms the basis of the obligation to ensure that the benefits flowing from the government backstop are as broadly available as possible, consistent with safety and soundness and taxpayer protection.

In recent months, at least three such proposals have been developed that preserve a federal backstop (see Mortgage Bankers Association, Bright and DeMarco, and Parrott et al. proposals). Should the administration and Congress pursue a strict privatization approach to reform, lacking a guarantee, it’s unlikely that any affordable housing obligations would be imposed in the reformed system. (cover page, footnotes omitted)

Stegman goes on to describe “The Affordable Housing Triad:”

Over the years, Congress has made it clear that the GSEs’ public purpose includes supporting the financing of affordable housing and promoting access to mortgage credit “throughout the nation, including central cities, rural areas, and underserved areas,” even if doing so involves earning “a reasonable economic return that may be less than the return earned on other activities.” As part of this mandate, policymakers have created a triad of affordable housing and credit access requirements:

  1. Meeting annual affordable-mortgage purchase goals set by the regulator;
  2. Paying an assessment on each dollar of new business to help capitalize two different affordable housing funds; and
  3. Developing and executing targeted duty-to-serve strategies, the purpose of which is to increase liquidity in market segments underserved by primary lenders and the GSEs, defined by both geography and housing types. (1, footnote omitted)

The paper outlines three bipartisan options that would not

compromise the obligation to provide liquidity to all corners of the market at the least possible cost, consistent with taxpayer protection and safety and soundness. Each option attempts to ensure that the system as a whole provides access and affordability at least as much as the existing system; includes an explicit and transparent fee on the outstanding balance of guaranteed MBS; and includes a duty to serve the broadest possible market. (3)

The paper is intended to spark further conversation about housing finance reform while advocating for the needs of low- and moderate-income households. I hope it succeeds in pushing Congress to focus on the details of what could be a bipartisan exit strategy from the endless GSE conservatorships.

 

Who Qualifies as a First-Time Homebuyer?

NewHomeSource quoted me in Who Qualifies as a First-Time Homebuyer? It opens,

You don’t always have to be a first-time homebuyer to qualify for down payment assistance programs.

As you consider purchasing a home, you may have come across down payment assistance programs that aim to assist first-time homebuyers.

“How can I qualify?” you might have asked yourself.

It turns out, you don’t always have to be a first-time homebuyer to qualify, even though it might say otherwise in the name.

“Freddie Mac defines ‘first-time homebuyers’ for its Home Possible program as someone who had ‘no ownership interest (sole or joint) in a residential property during the three-year period preceding the date of the purchase of the mortgage premises,’” says David Reiss, professor of law and research director for the Center for Urban Business Entrepreneurship at the Brooklyn Law School.

Freddie Mac, a government-sponsored home loan mortgage corporation, says that its Home Possible mortgages offer low down payments for low- to moderate-income homebuyers or buyers in high-cost or underserved communities.

Another federal mortgage association, Fannie Mae, also offers down payment assistance programs for first-time homebuyers.

“The Fannie Mae standard 97% LTV Options let first-time homebuyers put down 3 percent,” says Reiss. “The program defines a first-time homebuyer as someone who ‘had no ownership interest (sole or joint) in a residential property during the three-year period preceding the date of purchase of the security property.’”

Similarly, the U.S Department of Housing and Urban Development defines a first-time homebuyer as an individual who has had no ownership in a principal residence three years prior to the closing date of the property.

Not a first-time homebuyer under these definitions? There’s hope for you still.

“Given the overwhelming dominance that the FHA, Fannie and Freddie have on the mortgage market, homebuyers who have sat out of the housing market for a while may find that they qualify for first-time homebuyer programs even if they have owned a home before,” adds Reiss.

Additionally, there are also assistance programs available for “displaced homemakers.” A displaced homemaker generally meets the following qualifications:

  • Provided unpaid services to family members in the home, such as a stay-at-home parent,
  • Were given financial assistance from another family member, but are no longer supported by that income and
  • Are unemployed/underemployed with difficulty gaining employment or upgraded pay.

“A displaced homemaker or single parent will also be considered a first-time homebuyer if he or she had no ownership interest in a principal residence (other than a joint ownership interest with a spouse) during the preceding three-year time period,” Reiss says.