Tag Archives: Freddie Mac

What Happens if Fannie and Freddie Go Private?

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I was quoted in Fintech Nexus’ Home Invasion: What Happens if Fannie and Freddie Go Private. It reads, in part,

The Trump Administration has telegraphed significant changes to GSE mortgage lenders — with massive implications for the industry

Since his swearing in on March 14 as the fifth Director of the Federal Housing Finance Agency (FHFA), construction mogul William J. Pulte has executed major policy and personnel changes. Among other moves, Pulte has named himself board chair of the Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac, removed 14 of the GSEs’ 25 sitting board members, fired most of the companies’ audit boards, generally slashed headcount, and rescinded several Biden-era oversight-related advisory bulletins.

According to Professor David Reiss of Cornell Law School, a scholar of real estate finance and housing policy, Pulte’s simultaneous leadership of the FHFA in addition to roles at the GSEs, which have been under federal conservatorship since the 2008 financial crisis, is not normal.

“The whole point of regulation is you have somebody who’s overseeing an industry,” he told Fintech Nexus. “This is like the left hand [knowing] what the right hand is doing: You’re overseeing yourself, so it’s … kind of inconsistent with the notion of a supervisory regulator.”

Fintech Nexus contacted the FHFA, requesting that it comment on the impetus behind Pulte’s simultaneous self-appointments to Fannie and Freddie. The FHFA did not respond.

*     *    *

CAPITAL IDEAS

One idea percolating is for the Trump Administration to use Fannie and Freddie as a pool of capital to inject into a sovereign wealth fund. An op-ed in the Financial Times by Stifel CEO Ronald Kruszewski suggested this reconfiguration could provide “continued government backing,” “stabilize investor confidence,” and “pave the way for a $1 trillion sovereign wealth fund by 2040.”

However, in a letter to the editor in the Financial Times, Dini Ajmani, Former Deputy Assistant Secretary of the US Treasury, suggested the idea would fail, as any privatization of the GSEs would require proper capitalization, taxpayer compensation, and adequate confidence of securities investors.

“I believe the difficulty in meeting all three conditions is why [the] status quo has persisted,” Ajmani told Fintech Nexus. “To build capital, Fannie/Freddie must retain earnings, which means the taxpayer is not compensated. If the taxpayer is compensated through dividend payments, private capital will be uninterested because the agencies will be undercapitalized.”

To this end, FHFA Director Pulte may continue to atrophy many forms of GSE oversight as a way to prime the pump: Pre-empting congressional activity by deregulating Fannie and Freddie can accelerate their transition toward open-market frameworks.

The Trump Administration may see it as its only viable short-term  avenue, as many members of Congress are uninterested in bringing Fannie and Freddie out of conservatorship; Senator Elizabeth Warren (D-MA), member of the Senate Committee on Banking, Housing, and Urban Affairs, called the move “Great for billionaires, terrible for hardworking people.”

Should the Trump Administration succeed in its quest, we may see states attempting to fill in the gaps on regulatory accountability, rhyming with blue-state attorneys-general’s litigiousness in the wake of the Consumer Financial Protection Bureau’s de-clawing, though this is unlikely.

“State regulators do not generally play a role similar to the two companies (except to some small extent state Housing Finance Agencies),” Reiss of Cornell Law School said. “I could imagine state agencies trying to increase consumer protection for mortgage borrowers, if the federal regulatory environment changes, but we would have to see how that plays out to understand how the states would respond.”

Trump’s Plans to Privatize Fannie and Freddie

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from Cato Institute website, https://www.cato.org/people/mark-calabria

Mark Calabria, OMB Associate Director for Treasury, Housing, and Commerce

I was interviewed on  WBUR-FM’s On Point (distributed by American Public Radio), hosted by Meghna Chakrabarti for an episode on How Trump Plans To Get Government out of the Mortgage Business. The link has the recording of the show as well as a transcript.

The transcript of the interview starts,

CHAKRABARTI: Now that President Trump is back in the White House, it seems that he intends to get the job done this time around. Mark Calabria has returned to Trump’s administration, this time working on housing policy at the Office of Management and Budget. Bill Pulte is now director of FHFA, and he just made the highly unusual move of appointing himself chair of both Fannie Mae and Freddie Mac, making the regulator and the regulated basically the same.

Pulte also fired 14 of the 25 sitting board members at Fannie and Freddie. A shakeup many are suspecting is a first step in leading these two companies out of government control and into privatization. We’re talking about a huge part of the U.S. economy that underpins the housing market. So this hour, we want to explore what privatization of Fannie and Freddie actually means, what it should look like, and how it might have an impact on homeowners and the housing market.

So to do that, David Reiss joins us. He’s a clinical professor of law at Cornell Law School and Cornell Tech, an expert in housing finance and policy. Professor Reiss, welcome to On Point.

DAVID REISS: Meghna, thank you so much.

CHAKRABARTI: I have to tell you that I actually can’t believe that it’s been 17 years since the financial crisis of 2008.

Let’s dust off the memory banks professor and go back to before 2008 and start there. Can you just remind us like what Fannie Mae and Freddie Mac were, what their purpose was, who owned them, et cetera?

REISS: I’m gonna go even a little bit further back than Fannie and Freddie’s creation, because I think it’s really gonna help people visualize what’s at stake here.

And if you think back to the 19th century and somebody was trying to buy a house, they didn’t have that many options. A house has always been a very expensive thing to buy, so they need to borrow some money to buy a house. And how could you do that?

Maybe if you’re rich, you could do it, or had a rich uncle, but otherwise you need to go to somebody who has capital and that you could borrow it and give them some interest in return. And pay them back over time, and be able to live in that house while you’re paying back the amount of money that you borrowed. And so if people think of It’s a Wonderful Life where there’s the Bailey Brothers building in loans and where they, people deposit their small savings into the buildings and loan.

And then some people are then able to borrow some money from the buildings and loan for mortgages. And there’s the famous scene where there’s a panic at the bank. And Jimmy Stewart says, Mrs. Kennedy, your money is in Mrs. Smith’s house. And Mrs. Smith, your money is in Ms. Macklin’s house.

And that’s the way it was done in the 19th century and the early 20th century. But there were real limitations to that. Sometimes communities didn’t have a lot of capital to lend people, so maybe in out west or in the Midwest there wasn’t a lot of capital, like there might’ve been back east in Boston or New York.

And so people who could have handled the mortgage just didn’t have access to it. It was like they were living in a dry area, and the fresh flowing credit didn’t reach their dry community. So during the Great Depression and the New Deal the government started to intervene, to spread credit out across the country in a way that kind of provided liquidity to all the communities where people wanted to borrow.

And Fannie Mae was a creature of the New Deal, but really took off in the ’70s along with its sibling Freddie Mac. And effectively, what those two companies were designed by Congress to do was to ensure that capital could go across state borders in a way that banks were typically not allowed to do. And they effectively created at first a national market for mortgage credit, and effectively when they access the global credit markets over time, an international global market for credit. So they’re really intermediaries.

Temporary Interest Rate Buydowns

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I was quoted in This Strategy to Cut Mortgage Rates is Becoming Popular in Bay Area — but There are Pitfalls in the San Francisco Chronicle (paywall). It opens,

When first-time buyers Rachel Shatto and Randy Nelson purchased a home in Oakland in May, they negotiated an interest rate buydown that effectively lowered their mortgage rate, and thus their monthly payment, for the first two years.

Although the seller made a lump-sum payment for the short-term rate decrease at closing, they increased their purchase price to compensate for it. This temporary rate buydown left them with more cash to pay for repairs and improvements the first couple of years, Shatto said.

Both temporary buydowns, which effectively lower the rate for one to three years, and permanent ones, which reduce it for the life of the loan, have become more popular since interest rates started soaring last year.

In June, 2.8% of 30-year fixed-rate loans funded by Freddie Mac had temporary buydowns, up from near zero a year ago but down from a peak of 7.6% in December 2022, shortly after rates spiked above 7% for the first time in more than two decades. After dipping as low as 6.14% in February, they surged above 7% again in August and now stand at 7.18%.

Buydowns are most common on new homes. When rates rise, builders frequently offer temporary or permanent buydowns as one of several incentives buyers can choose from.

A survey of builders in August asked what has been the most effective way to get buyers off the sidelines. The No. 1 answer, cited by 69% of respondents, was mortgage-rate buydowns, said Ali Wolf, chief economist with Zonda, a new-home data and consulting firm that did the survey. Only 22% said price cuts.

“When they lower prices, buyers already under contract at a higher price tend to cancel their contracts and it becomes a vicious cycle,” Wolf said.

Landsea Homes is offering buydowns on select homes in select communities including the newly opened Alameda Marina. “We are only able to offer them on homes that we can deliver within 30 to 60 days,” said Josh Santos, Landsea’s Northern California division president. “I’d say 75% of our buyers in the last 60 days” chose buydowns in lieu of other incentives such as options, upgrades or homeowners association dues.

Some sellers are also offering them on existing homes that have been sitting for a while.

Whether they make sense for buyers depends on myriad factors including their overall finances, the cost versus savings, how long they plan to stay in the home, whether they spend or invest their monthly savings, who’s actually paying for them, and future interest rates, the last of which is unknowable.

Borrowers should make sure they understand how buydowns work, the potential pitfalls and other ways to save money on a mortgage.

How permanent buydowns work

A permanent rate buydown is fairly straightforward. The buyer pays fees, called discount points, to reduce the interest rate — and therefore the monthly payment — forever.

One discount point equals 1% of the loan amount. To lower the note rate by 1 percentage point, a buyer today might pay around three points to four points. This cost can vary widely depending on the day, the lender and other factors, said Westin Miller, branch manager with Pinnacle Home Loans in Santa Rosa.

To figure out how long it would take for your monthly savings to equal the points paid, divide the total upfront fee by your monthly mortgage payment (or plug the numbers into an online mortgage discount points calculator).

Suppose a buyer can permanently lower the rate on a $700,000 mortgage to 6.5% from 7.5% by paying three points, or $21,000. That would lower the monthly payment by about $470 a month.

Divide $21,000 by $470 you get 36 months, which is the breakeven point. A borrower who kept the loan for more than three years would come out ahead. The longer it was kept, the bigger the benefit.

If a buyer knew for sure that rates were coming down soon, it might be better to take the higher rate with no points and refinance when rates drop, although refinancers will generally have to pay some closing costs again.

“If you are going to sell or refinance in a few years, paying points doesn’t make sense,” said Jeff Ostrowski, a Bankrate analyst.

Some buyers get permanent buydowns because they need a lower rate to qualify for a loan, said Jason Barnes, mortgage sales supervisor with U.S. Bank in Campbell.

Buyers pay for permanent buydowns, but in a slow market they might be able to negotiate a credit from the seller at closing to help pay for it.

How temporary buydowns work

With a temporary buydown, the borrower typically takes out a 30-year fixed-rate loan but makes payments based on a lower interest rate during the first one, two or three years in exchange for a one-time payment that is deposited into an escrow account at closing.

The upfront payment is about equal to the interest savings during the discount period.

During this period, the borrower makes payments at the lower rate and the mortgage servicer draws from the account to make up the difference. At the end of the discount period, the borrower makes the full payment.

Suppose the note rate is 7.5%. With a 1/0 buydown, the buyer makes payments based on a 6.5% rate the first year and 7.5% in years two through 30.

With a 2/1 buydown the borrower pays at 5.5% the first year, 6.5% the second year and 7.5% in all remaining years.

Three-year buydowns are available but not too popular because of the steep price.

The borrower generally must qualify for the loan based on the note rate stated in the loan agreement, in this case 7.5%.

Most lenders require sellers to pay for temporary buydowns, meaning the cost comes out of their proceeds at closing. If the buyer has no choice between a true seller-paid buydown and a lower price, there’s little reason not to take the buydown.

In competitive situations, buyers might need to increase their purchase price to cover some or all of the buydown payment, in which case they’re paying for it indirectly. Here the cost/benefit analysis gets more complicated.

A real-life example

When Shatto and Nelson bought their “cute little 1927 Tudor revival” in Oakland, they took out a 30-year loan with a 2/1 buydown from LaSalle Mortgage, Shatto said. They’re paying based on a rate of 4.125% for the first year, 5.125% the second and 6.125% thereafter.

Over the first two years, the buydown will save them $15,470 in interest, which was the cost of the buydown.

Although the seller paid for the buydown, the buyers paid a higher price to compensate, said their agent Lindsay Ferlin of Red Oak Realty.

Did they make a good deal? Here’s one way to look at it.

They paid $866,000 and, with a 20% down payment, and borrowed $692,800. Had they not used a buydown and paid $15,470 less, they would have borrowed $680,424 with 20% down.

With the higher loan amount, they’d repay an extra $27,071 over 30 years — consisting of $14,695 in interest and $12,376 in principal. But during the first two years, they’d save a total of $15,470, and most people don’t keep a mortgage for 30 years.

“Outside of a few cases, this does not have a significant economic benefit for borrowers,” said David Reiss, a professor of real estate law at Brooklyn Law School. “It’s a little bit of smoke and mirrors. I don’t think it improves their financial condition other than in a few cases where you have a low income in the present and expect it to grow significantly after a couple of years.”

A Controversial Fix for America’s Housing Market

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Sustainable Economies Law Center

Insider quoted me in A Controversial Fix for America’s Housing Market: More Foreclosures. It opens,

How many people should lose their homes to foreclosure?

In an ideal world, of course, there would be no foreclosures at all. Everyone who buys a home would get one that fits their income and needs, and people would have enough money to make their mortgage payments on time and in full. But in a housing market built on debt, foreclosures are a painful reality. People lose their jobs or fall behind on payments, and lenders repossess the home to recoup their losses.

Too many foreclosures is obviously a bad thing — losing a home is devastating both financially and emotionally — but it’s also a problem to have too few foreclosures. Low rates of foreclosure activity signal that housing lenders aren’t taking enough risk, locking out hopeful buyers who could have kept up with payments on their mortgage if only lenders gave them the chance.

Most residential loans are backed by the government-sponsored enterprises Fannie Mae and Freddie Mac or the Federal Housing Administration. To try to find a happy medium of risk, the GSEs — government-sponsored enterprises — and FHA set a “credit box” to determine who gets a mortgage. The companies base these standards on factors including the borrower’s financial stability and the state of the housing market and economy. When the credit box gets tighter, fewer people get mortgages, and foreclosures generally go down. When it opens up, banks take more risks on people with lower credit scores or worse financial histories, increasing the possibility of foreclosures.

Finding the right size for the credit box is easier said than done. In the years leading up to the Great Recession, banks and private lenders handed out millions of risky loans to homebuyers who had no hope of repaying them. A tidal wave of foreclosures followed, plunging the US housing market — and the global economy — into chaos.

But some experts argue that in the years since the crash, the GSEs, lenders, and regulators overcorrected, shutting loads of potentially reliable buyers out of the housing market. Laurie Goodman, the founder of the Housing Finance Policy Center at the Urban Institute, a nonpartisan think tank, said there’s room today to “open the credit box” and relax lending standards without pushing the housing market into crisis. More foreclosures might come as a result, she said, but that would be “a worthwhile trade-off” if it gave more people the opportunity to build wealth through homeownership.

Opening the credit box isn’t a cure-all for housing, and given the weakening economy, more cautious experts argue that making it easier to get a mortgage is unnecessary or dangerous. But if lenders do it correctly, it could be a major step toward a healthier market. A more stable credit box over time could not only ensure future homebuyers aren’t locked out of getting the home of their dreams, but could also smooth out some of the market’s chaotic nature.

The ‘invisible victims’ of the housing market

In the aftermath of the Great Recession, the victims of the housing free-for-all were clear. An estimated 3.8 million homeowners lost their homes to foreclosure from 2007 to 2010, and plenty more also lost theirs in the following years. But the overly strict lending standards and tighter regulations that followed created a new class of victims: people who were unable to join the ranks of homeowners. David Reiss, a professor at Brooklyn Law School, called these would-be homebuyers “invisible victims” — people who probably could have stayed current on their payments if they’d been approved for a loan but who didn’t get that opportunity.

Rising Mortgage Rates

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graphic by Chris Butterworth

NBC News quoted me in Mortgage Rates Just Hit 5 Percent: What Does That Mean for Homebuyers and Owners? It opens,

Mortgage rates crossed the 5 percent line on Wednesday for the first time since 2011, marking a new era for a generation of Americans raised on super-low borrowing rates and highlighting the downside of a burgeoning national economy.

Strengthening economic growth, near-record low unemployment, inflation rates and policy moves by the Federal Reserve have all contributed to move the needle beyond the psychological 5 percent barrier.”It has only been in this decade that they have fallen below 5 percent, rates not seen since the 1960s,” said David Reiss, an expert in real estate law and professor at the Brooklyn Law School.

From 1971 through early October 2008, the average rate for a 30-year mortgage was 8.1 percent. The day before Halloween 1981, the number spiked at 18.44 percent, according to data from Freddie Mac, the government-sponsored mortgage rebundler.

Psychology aside, there’s a real money impact as well. Every increase of 10 basis points, or 0.1 percentage point, means another $6 per month per $100,000 of mortgage, said Danielle Hale, chief economist for Realtor.com.

Over the last year, the mortgage on a typically priced home of $295,000 has increased by $115 to $120 a month.

Growing monthly payments are just one of the factors contributing to tougher times for many buyers. House prices also have been on the increase, and potential homeowners must contend with the loss of the so-called SALT deductions in last year’s tax cut legislation, which complicate things in high-tax states.

De Facto Housing Finance Reform

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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

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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.