Tag Archives: fannie

Are The Stars Aligning For Fannie And Freddie Reform?

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Law360 published my op ed, Are The Stars Aligning For Fannie And Freddie Reform? It reads,

There has been a lot of talk of the closed-door discussions in the Senate about a reform plan for Fannie Mae and Freddie Mac, the two mammoth housing finance government-sponsored enterprises. There has long been a bipartisan push to get the two entities out of their conservatorships with some kind of permanent reform plan in place, but the stars never aligned properly. There was resistance on the right because of a concern about the increasing nationalization of the mortgage market and there was resistance on the left because of a concern that housing affordability would be unsupported in a new system. It looks like the leader of that right wing, House Financial Services Committee Chairman Jeb Hensarling, R-Texas, has indicated that he is willing to compromise in order to create a “sustainable housing finance system.” The question now is whether those on the left are also willing to compromise in order to put that system on a firm footing for the 21st century.

In a speech at the National Association of Realtors, Hensarling set forth a set of principles that he would be guided by:

  • Fannie Mae and Freddie Mac must be wound down and their charters repealed;
  • Securitizers need strong bank-like capital and community financial institutions must be able to compete on a level playing field;
  • Any new government affordable housing program needs to at least be on budget, be results-based and target actual homebuyers for the purpose of buying a home they can actually afford to keep;
  • The Federal Housing Administration must return to its traditional role of serving the first-time homebuyer and low- and moderate-income individuals.

I am not yet sure that all of the stars are now aligned for Congress to pass a GSE reform bill. But Hensarling’s change of heart is a welcome development for those of us who worry about some kind of slow-moving train wreck in our housing finance system. That system has been in limbo for nearly a decade since Fannie and Freddie were placed in conservatorship, with no end in sight for so long. Ten years is an awfully long time for employees, regulators and other stakeholders to play it by ear in a mortgage market measured in the trillions of dollars.

Even with a broad consensus on the need for (or even just the practical reality of) a federal role in housing finance, there are a lot of details that still need to be worked out. Should Fannie and Freddie be replaced with many mortgage-backed securities issuers whose securities are guaranteed by some arm of the federal government? Or should Fannie and Freddie become lender-owned mutual insurance entities with a government guarantee of the two companies? These are just two of the many options that have been proposed over the last 10 years.

Two housing finance reform leaders, Sens. Bob Corker, R-Tenn., and Mark Warner, D-Va., appear to favor some version of the former while Hensarling seems to favor the latter. And Hensarling stated his unequivocal opposition to some form of a “recap and release” plan, whereas Corker and Warner appear to be considering a plan that recapitalizes Fannie and Freddie and releases them back into private ownership, to the benefit of at least some of the companies’ shareholders. The bottom line is that there are still major differences among all of these important players, not to mention the competing concerns of Sen. Elizabeth Warren, D-Mass., and other progressives. Warren and her allies will seek to ensure that the federal housing system continues to support meaningful affordable housing initiatives for both homeowners and renters.

Hensarling made it clear that he does not favor a return to the status quo — he said that the hybrid GSE model “cannot be saved, it cannot be salvaged, it must not be resurrected, and needs to be scrapped.” But Hensarling also made it clear that he will negotiate and compromise. This represents a true opening for a bipartisan bill. For everyone on the left and the right who are hoping to create a sustainable housing finance system for the 21st century, let’s hope that his willingness to compromise is widely shared in 2018.

I am now cautiously optimistic that Congress can find some common ground. With Hensarling on board, there is now broad support for a government role in the housing sector. There is also broad support for a housing finance infrastructure that does not favor large financial institutions over small ones. Spreading the risk of default to private investors — as Fannie and Freddie have been doing for some time now under the direction of their regulator — is also a positive development, one with many supporters. Risk sharing reduces the likelihood of a taxpayer bailout in all but the most extreme scenarios.

There are still some big sticking points. What should happen with the private investors in Fannie and Freddie? Will they own part of the new housing finance infrastructure? While the investors have allies in Congress, there does not seem to be a groundswell of support for them on the right or the left.

How much of a commitment should there be to affordable housing? Hensarling acknowledges that the Federal Housing Administration should serve first-time homebuyers and low- and moderate-income individuals, but he is silent as to how big a commitment that should be. Democrats are invested in generating significant resources for affordable housing construction and preservation through the Affordable Housing Trust Fund. Hensarling appears to accept this in principle, while cautioning that any “new government affordable housing program needs to at least be on budget, results based, and target actual homebuyers for the purpose of buying a home they can actually afford to keep.” Democrats can work with Hensarling’s principles, although the extent of the ultimate federal funding commitment will certainly be hotly contested between the parties.

My cautious optimism feels a whole lot better than the fatalism I have felt for many years about the fate of our housing finance system. Let’s hope that soon departing Congressman Hensarling and Sen. Corker can help focus their colleagues on creating a housing finance system for the 21st century, one with broad enough support to survive the political winds that are buffeting so many other important policy areas today.

Single-Family Rental Securitizations Here To Stay?

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photo by David McBee

Kroll Bond Rating Agency has released Single-Borrower SFR: Comprehensive Surveillance Report. It has lots of interesting tidbits about this new real estate finance sector (it has only been four years since its first securitization):

  • Six single-family rental operators own nearly 180,000 homes. (3)
  • Of the 33 SFR securitizations issued to date ($19.2 billion), nine deals ($4.6 billion) have been repaid in full without any interest shortfalls or principal losses. (4)
  • the Federal Housing Finance Agency (FHFA), which regulates Freddie Mac and Fannie Mae, announced that it had authorized Freddie Mac to enter the single-family rental sector on a limited basis to provide up to $1.0 billion of financing or loan guarantees. Freddie Mac reportedly is expected to focus on small-scale and midsize landlords that invest in SFR properties that the GSE considers to be affordable rental housing, not institutional issuers such as Invitation Homes, which owns and manages nearly 50,000 SFR properties. (5)
  • The largest five exposures account for 39.4% of the properties and include Atlanta (11,822 homes; 13.0%), which represents the CBSA with the greatest number of properties, followed by Tampa (6,374; 7.0%), Dallas (6,199; 6.8%), Phoenix (5,780; 6.3%), and Charlotte (5,733; 6.3%). (6)
  • The highest home price appreciation since issuance was observed in CAH 2014-1, at 30.7%. On average, collateral homes included in the outstanding transactions issued during 2014, 2015, 2016 and 2017 have appreciated in value by 25.0%, 18.0%, 8.7% and 3.2%, respectively. It is worth noting that the rate of the home price appreciation on a national basis and in the regions where the underlying homes are located has slowed in recent years. (7)
  • Since issuance, the underlying collateral has generally exhibited positive operating performance with the exception of expenses. Contractual rental rates have continued to increase, vacancy and tenant retention rates have remained relatively stable, and delinquency rates have remained low. Servicer reported operating expenses, however, continue to be higher than the issuer underwritten figures at securitization. (7)

Analysts did not believe that single-family rentals could be done at scale before the financial crisis. But investors were able to sweep up tens of thousands of homes on the cheap during the foreclosure crisis and the finances made a lot of sense. It will be interesting to see how this industry matures with home prices appreciating and expenses rising. I am not making any predictions, but I wonder when it will stop making sense for SFR operators to keep buying new homes.

How Important Is Skin in The Game?

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Haoyang Liu has posted a paper to SSRN that challenges the effectiveness of skin-in-the-game market discipline: Does Skin-in-the-Game Discipline Risk Management? Evidence from Mortgage Insurance. The abstract reads,

Many mortgage reform proposals suggest replacing Fannie Mae and Freddie Mac (the GSEs) with private entities. A common assumption underlying these proposals is that unlike the GSEs, private insurers will properly manage risk and set fair prices. Inconsistent with this assumption, this paper presents evidence that private insurers less effectively managed home price risks during the 2000-2006 housing boom than the GSEs did. Mortgage origination data reveal that the GSEs were selecting loans with increasingly higher percentages of down payments, or lower loan to value ratios (LTVs), in boom areas than in other areas. These lower LTVs in boom areas reduced the GSEs’ exposure to overheated markets. Furthermore, the decline of LTVs in boom areas stems entirely from the segment insured by the GSEs only, and none of the decline stems from the segment where private mortgage insurers take the first loss position. Private insurers also did not lower their exposure to home price risks along other dimensions, including the percentage of high LTV GSE loans they insured and the percentage of insured mortgage balance. My results highlight that post-crisis reform of the mortgage insurance industry should carefully consider additional factors besides moral hazard induced by the government guarantees, such as mortgage insurers’ future home price assumptions and the industry organization of the mortgage origination chain.

The paper’s conclusions are sobering for those interested in increasing the role of private capital in the mortgage market (including yours truly):

Many mortgage market reform proposals assume that private insurers will set fair prices and properly manage risk. Evidence from this paper suggests that private insurers less effectively managed home price risk during the 2000-2006 housing boom than Fannie and Freddie did.

These somewhat surprising results are nevertheless consistent with the history of the private mortgage insurance industry, including its repeated and concentrated failures. Most recently in the 2008 crash, three out of the eight largest private mortgage insurers failed. However, perhaps 31 overshadowed by the highly publicized and controversial bailout of the GSEs, private mortgage insurers’ failures have received relatively little attention from academics and the popular press. Many post-crisis proposals also assume that replacing the GSEs by private insurers would be a panacea. My results suggest that privatizing the GSEs alone is unlikely to ensure sufficient risk management in the mortgage insurance industry. Additional factors besides private capital, such as assumptions about future house prices and bargaining power of private insurers in front of large lenders, are important in shaping risk management practices. One way to establish reasonable house price assumptions is to stress test mortgage insurers, forcing the industry to consider their exposure to the housing downturn scenarios proposed by regulators.

The mortgage insurance industry plays a crucial role in financing Americans’ mortgages. Their insurance reduces or removes mortgage default risks, thereby enhancing the liquidity of mortgage backed securities and lowering homebuyers’ borrowing costs. The risks they face and the optimal regulatory structure for them deserve more study to prevent them from being a source of systemic risk in the financial system. (31-32)

The paper suggests that we should not expect that private mortgage insurers can play an outsized role in keeping us safe from booms and busts. They have succumbed to bubble thinking in the past and there is no reason to think that they would not in the future as well.

Fannie and Freddie Visit the Supreme Court

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Justice Gorsuch

Fannie and Fredddie investors have filed their petition for a writ of certiorari in Perry Capital v. Mnuchin. The question presented is

Whether 12 U.S.C. § 4617(f), which prohibits courts from issuing injunctions that “restrain or affect the exercise of powers or functions of” the Federal Housing Finance Agency (“FHFA”) “as a conservator,” bars judicial review of an action by FHFA and the Department of Treasury to seize for Treasury the net worth of Fannie Mae and Freddie Mac in perpetuity. (i)

What I find interesting about the brief is that relies so heavily on the narrative contained in Judge Brown’s dissent in the Court of Appeals decision. As I had noted previously, I do not find that narrative compelling, but I believe that some members of the court would, particularly Justice Gorsuch. The petition’s statement reads in part,

In August 2012—nearly four years after the Federal Housing Finance Agency (“FHFA”) placed Fannie Mae and Freddie Mac1 in conservatorship during the 2008 financial crisis—FHFA, acting as conservator to the Companies, agreed to surrender each Company’s net worth to the Treasury Department every quarter. This arrangement, referred to as the “Net Worth Sweep,” replaced a fixed-rate dividend to Treasury that was tied to Treasury’s purchase of senior preferred stock in the Companies during the financial crisis. FHFA and Treasury have provided justifications for the Net Worth Sweep that, as the Petition filed by Fairholme Funds, Inc. demonstrates, were pretextual. The Net Worth Sweep has enabled a massive confiscation by the government, allowing Treasury thus far to seize $130 billion more than it was entitled to receive under the pre-2012 financial arrangement—a fact that neither Treasury nor FHFA denies. As was intended, these massive capital outflows have brought the Companies to the edge of insolvency, and all but guaranteed that they will never exit FHFA’s conservatorship.

Petitioners here, investors that own preferred stock in the Companies, challenged the Net Worth Sweep as exceeding both FHFA’s and Treasury’s respective statutory powers. But the court of appeals held that the Net Worth Sweep was within FHFA’s statutory authority, and that keeping Treasury within the boundaries of its statutory mandate would impermissibly intrude on FHFA’s authority as conservator.

The decision of the court of appeals adopts an erroneous view of conservatorship unknown to our legal system. Conservators operate as fiduciaries to care for the interests of the entities or individuals under their supervision. Yet in the decision below, the D.C. Circuit held that FHFA acts within its conservatorship authority so long as it is not actually liquidating the Companies. In dissent, Judge Brown aptly described that holding as “dangerously far-reaching,” Pet.App. 88a, empowering a conservator even “to loot the Companies,” Pet.App. 104a.

The D.C. Circuit’s test for policing the bounds of FHFA’s statutory authority as conservator—if one can call it a test at all—breaks sharply from those of the Eleventh and Ninth Circuits, which have held that FHFA cannot evade judicial review merely by disguising its actions in the cloak of a conservator. And it likewise patently violates centuries of common-law understandings of the meaning of a conservatorship, including views held by the Federal Deposit Insurance Corporation (“FDIC”), whose conservatorship authority under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), served as the template for FHFA’s own conservatorship authority. Judge Brown correctly noted that the decision below thus “establish[es] a dangerous precedent” for FDIC-regulated financial institutions with trillions of dollars in assets. Pet.App. 109a. If the decision below is correct, then the FDIC as conservator could seize depositor funds from one bank and give them away—to another institution as equity, or to Treasury, or even to itself—as long as it is not actually liquidating the bank. The notion that the law permits a regulator appointed as conservator to act in a way so manifestly contrary to the interests of its conservatee is deeply destabilizing to our financial regulatory system. (1-2)

We shall see if this narrative of government overreach finds a sympathetic ear at the Court.

Mortgage Servicing Since The Financial Crisis

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photo by Dan Brown

Standard & Poors issued a report, A Decade After The Financial Crisis, What’s The New Normal For Residential Mortgage Servicing? It provides a good overview of how this hidden infrastructure of the mortgage market is functioning after it emerged from the crucible of the subprime and foreclosure crises. It reads, in part,

Ten years after the start of the financial crisis, residential mortgage servicing is finally settling into a new sense of normal. Before the crisis, mortgage servicing was a fairly static business. Traditional prime servicers had low delinquency rates, regulatory requirements rarely changed, and servicing systems were focused on core functions such as payment processing, investor accounting, escrow management, and customer service. Subprime was a specific market with specialty servicers, which used high-touch collection practices rather than the low-touch model prime servicers used. Workout options for delinquent borrowers mainly included repayment plans or extensions. And though servicers completed some modifications, short sales, and deeds in lieu of foreclosure, these were exceptions to the normal course of business.

Today, residential mortgage servicing involves complex regulation, increased mandatory workout options, and multiple layers of internal control functions. Over the past 10 years servicers have had to not only modify their processes, but also hire more employees and enhance their technology infrastructure and internal controls to support those new processes. As a result, servicing mortgage loans has become less profitable, which has caused loan servicers to consolidate and has created a barrier to entry for new servicers. While the industry expects reduced regulatory requirements under the Trump administration and delinquency rates to continue to fall, we do not foresee servicers reverting to pre-crisis operational processes. Instead, we expect states to maintain, and in some cases enhance, their regulatory requirements to fill the gap for any lifted or reduced at the federal level. Additionally, most mortgage loan servicers have already invested in new processes and technology, and despite the cost to support these and adapt to any additional requirements, we do not expect them to strip back the controls that have become their new normal. (2/10, citation omitted)

*     *     *

As The Economy Improves, Delinquency Rates Have Become More Stable

Total delinquency rates have only just begun returning to around pre-crisis levels as the economy–and borrowers’ abilities to make their mortgage payments–has improved (see charts 1 and 2). Lower delinquency rates can also be attributed to delinquent accounts moving through the default management process, either becoming reperforming loans after modifications or through liquidation. New regulatory requirements have also extended workout timelines for delinquent accounts. In 2010, one year after 90-plus delinquency rates hit a high point, the percentage of prime and subprime loans in foreclosure actually surpassed the percentage that were more than 90 days delinquent–a trend that continued until 2013 for prime loans and 2014 for subprime loans. But since the end of 2014, all delinquency buckets have remained fairly stable, with overall delinquency rates for prime loans down to slightly over 4% for 2016 from a peak of just over 8% in 2009. Overall delinquency rates for subprime loans have fluctuated more since the peak at 29% in 2009. (2/10)

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Modifications Now Make Up About Half Of Loan Workout Strategies

Government agencies and government-sponsored enterprises (Fannie Mae and Freddie Mac) developed new formal modification programs beginning in 2008 to address the rising delinquency and foreclosure rates. The largest of these programs was HAMP, launched in March 2009. While HAMP was required for banks accepting funds from the Troubled Asset Relief Program (TARP), all servicers were allowed to participate. These programs required that servicers exhaust all loss mitigation options before completing foreclosure. This requirement, and the fact that servicers started receiving incentives to complete modifications, spurred the increase in modifications. (4/10)

*     *     *

Foreclosure Timelines Have Become Longer

As the number of loans in foreclosure rose during the financial crisis, the requirements associated with the foreclosure process grew. As a result, the time it took to complete the foreclosure process increased to almost 475 days in 2016 from more than 160 days in 2007–an increase of almost 200%. While this is not a weighted average and therefore not adjusted for states with smaller or larger foreclosure portfolios, which could skew the average, the data show longer timelines across all states. And even though the percentage of loans in foreclosure has decreased in recent years (to 1% and 9% by the end of 2016 for prime and subprime, respectively, from peaks of 3% in 2010 and 13% in 2011) the time it takes to complete a foreclosure has still not lessened (6/10)

FHFA’s Strategic Plan for Fannie and Freddie

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The Federal Housing Finance Agency released its Strategic Plan for fiscal years 2018-2022 for public input. As discussed in yesterday’s post, Director Watt is very focused on maintaining the health of Fannie Mae and Freddie Mac. The Strategic Plan reiterates that focus:

As conservator of the Enterprises, FHFA will also promote stability by working to preserve and conserve the Enterprises’ assets and business operations. Additionally, FHFA will encourage the Enterprises and the housing industry to adopt standards and practices that promote market and stakeholder confidence. (8)

The Plan goes into depth to describe the FHFA’s role as conservator:

The Enterprises were placed into conservatorships in September 2008 in the midst of a severe financial crisis. Their ongoing participation in the housing finance market has been an important factor in maintaining market liquidity and stability. Conservatorship permitted the U.S. Government to take greater control over management of the Enterprises and gave investors in the Enterprises’ debt and MBS confidence that the Enterprises would have the capacity to honor their financial obligations. As conservator, FHFA establishes restrictions and expectations for the Enterprises’ boards and for their managements while authorizing them to conduct the Enterprises’ day-to-day operations.

As detailed earlier, FHFA’s authority as both regulator and conservator of the Enterprises is based upon statutory mandates. FHFA, acting as regulator and conservator, must follow the mandates assigned to it by statute and the missions assigned to the Enterprises by their charters. Congress may choose to revise the statutory mandates governing the Enterprises at any time.

*      *     *

The Enterprises are also parties to PSPAs with the Treasury Department. Under the PSPAs, the Enterprises are provided U.S. taxpayer backing with explicit dollar limits. The PSPA commitment still available to Fannie Mae is $117.6 billion and the commitment still available to Freddie Mac is $140.5 billion. Additional draws would reduce these commitments, and dividend payments do not replenish or increase the commitments under the terms of the PSPAs. Starting in 2013, the PSPAs provided each Enterprise with a capital buffer of $3 billion to protect each Enterprise against making additional draws of taxpayer support in the event of an operating loss in any quarter, and the PSPAs provide mandated declines of $600 million each year to these capital buffers. On January 1, 2017, each Enterprise’s capital buffer declined to $600 million and the capital buffer is scheduled to decline to zero on January 1, 2018.

FHFA continues to encourage Congress to complete the important work of housing finance reform. FHFA has reiterated the urgency of reform and that it is up to Congress to determine what future, if any, the Enterprises will have in the future housing finance system. (16-17)

Reading between the lines, I see the FHFA under Watt doing whatever it has to in order to maintain stability and liquidity in the mortgage markets. If Congress does not act, if the Treasury does not act, I think that Director Watt will go it alone and do what it takes to maintain Fannie and Freddie’s reputation with mortgage lenders and MBS investors.

Watt’s Happening with Fannie and Freddie?

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FHFA Director Watt

Federal Housing Finance Agency Director Watt testified before the House Committee on Financial Services today and gave a good overview of the decade-long conservatorship of Fannie and Freddie.  He also gave some sense of the urgency of coming up with at least a stopgap measure before the two companies’ capital buffer drops to zero at the end of the year pursuant to the terms of the Senior Preferred Stock Purchase Agreements (PSPAs) that govern the two companies’ relationship with the Treasury. He stated that it would

be a serious misconception for members of this Committee, or for anyone else, to consider any actions FHFA may take as conservator to avoid additional draws of taxpayer support either as interference with the prerogatives of Congress, as an effort to influence the outcome of housing finance reform, or as a step toward recap and release. FHFA’s actions would be taken solely to avoid a draw during conservatorship.

This signifies to me that he is planning on doing something other than reducing the capital buffer to $0.  As far as I can tell, Watt is playing a game of chicken with Congress — if you do not act, I will.

It is not clear to me clear how much authority Watt has or thinks he has to change the rules relating to the capital buffer. Does he think that he could act inconsistent with the PSPAa and withhold capital?  I have not seen a legal argument that says he could.  Is he willing to do it and be sued by Treasury?  These are speculative questions, but I do think that he has laid the groundwork for taking action if Congress and Treasury do not.

It does not seem to me that he was much wiggle room according to the terms of the PSPAs themselves, except perhaps to delay making the net worth sweep at the end of this year by converting it to an annual sweep or by some other mechanism.  That will be a short-term fix.

Given his strong language — “FHFA’s actions would be taken solely to avoid a draw during conservatorship” — I think he might be prepared to take an action that is inconsistent with the plain language of the PSPAs in order to act in a way that he thinks is consistent with his duty as the conservator.  This is less risky than it sounds because the only party that would seem to have standing to sue would be the Treasury, the counter-party to the PSPAs.  One could imagine that the Treasury would prefer to negotiate a response with the FHFA or await Watt’s departure rather than to have a judge decide the issue.  One could also imagine that Treasury would go along with the FHFA without explicitly condoning its actions, particularly if its actions soothed a turbulent market for Fannie and Freddie mortgage-backed securities.

Watt has consistently signaled that he will act if no other responsible party does and he emphasized that again today.