Tag Archives: Freddie Mac

Reiss on the Future of Fannie and Freddie

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I will be speaking at NYU Law next week on

The Future of Fannie and Freddie

Friday, September 20, 2013
9:00 am – 5:00pm
Reception to follow

Greenberg Lounge, NYU School of Law
40 Washington Square South
New York, NY 10012

Jointly sponsored by:
The Classical Liberal Institute & NYU Journal of Law & Business

 

This conference will bring together leaders in law, finance, and economics to explore the challenges to investment in Fannie Mae and Freddie Mac, and the future possibilities for these government-sponsored entities (GSEs).  Panels will focus on the reorganization of Fannie and Freddie, as well as the recent litigation surrounding the Treasury’s decision to “wind down” these GSEs.  Panelists will explore the legal issues at stake in the wind down, including the administrative law and Takings Clause arguments raised against the Treasury and Federal Housing Finance Agency.  Panelists will also look at economic policy and future prospects for Fannie and Freddie in light of legislation proposed in the House and the Senate.

Conference Panels:

  • The Reorganization of Fannie Mae and Freddie Mac
  • Fannie Mae, Freddie Mac, and Administrative Law
  • Conservatorship and the Takings Clause
  • The Future of Fannie and Freddie

Confirmed Participants:

  • Professor Barry Adler (NYU)
  • Professor Adam Badawi (Washington University)
  • Professor Anthony Casey (Chicago)
  • Charles Cooper (Cooper & Kirk PLLC)
  • Professor Richard Epstein (NYU)
  • Randall Guynn (Davis Polk & Wardwell LLP)
  • Professor Todd Henderson (Chicago)
  • Professor Troy Paredes (former SEC Commissioner)
  • Professor David Reiss (Brooklyn)
  • Professor Lawrence White (NYU Stern)

Thrilla in Vanilla: Freddie v. Jumbo

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Kroll BondRatings issued an RMBS Commentary, Mortgage Credit Trends:  Freddie Mac vs. Prime Jumbo. This commentary is important because it offers some help in evaluating the proposed “risk sharing” securitizations that Fannie and Freddie are considering. It is also important because if compares plain vanilla agency issues with comparable private label jumbos as well as not-so-comparable limited doc jumbos.  The differences are revealing.

Kroll’s key findings are

  • Freddie Mac default and loss rates were much higher for vintages that experienced severe home price declines. The worst vintage was 2007, which experienced an estimated aggregate home price decline in excess of 18% with 12.3% of the original vintage balance liquidated to date.
  • A rapid and significant improvement in credit characteristics sharply curtailed Freddie Mac mortgage liquidation rates, which fell from 8.3% for the 2008 vintage to 0.9% for the 2009 vintage.
  • Current Freddie Mac originations continue to be of very high credit quality, with a weighted average (WA) FICO score of 767 and a WA loan-to-value ratio (LTV) of 70% for the 2012 vintage.
  • Credit performance of jumbo prime mortgages and Freddie Mac mortgages is highly comparable when controlling for characteristics such as FICO, LTV, balance, and income and asset documentation. (2)

I am most interested in the last finding. While Kroll controlled for many characteristics, the fact remained that Freddie, as a general rule, allows for fewer high risk characteristics like low doc loans and high CLTV [combined loan to value]. For instance, almost all of Freddie’s loans were full doc while about half of the private label loans were low doc. So, while Kroll appears to be correct in stating “that the credit analysis tools developed for analyzing jumbo prime loans can be productively applied to agency mortgages,” we should not take that to mean that the two products are effectively the same. (7)

 

Fannie and Freddie Myth-Statement

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Fannie Mae and Freddie Mac’s investors have sued the federal government in Washington Federal v. United States, No. 1:13-00385 (June 10, 2013), for how it bailed out the two companies and thereby the nation’s housing market at the expense of the two companies’ shareholders. Plaintiffs claim that they have been damaged to the tune of $41 billion.

The complaint contains one of my favorite myths about the two companies.  It states that its regulator “directed that, to support the economy, the Companies purchase subprime and other risky securities.” (1) Its evidence for this assertion is that in 2007 the two companies’ “lending standards were adjusted to allow them to purchase more subprime securities” and “Congress and regulators encourage” the companies to “buy subprime and other risky securities — products that did not meet either Company’s own prior lending standards.”(1-2) The misleading nature of these statements is two-fold. First, Fannie and Freddie had been investing in non-prime securities before 2007; and (2) being ‘allowed’ or ‘encouraged’ to invest is not the same as being ‘directed’ to invest.  This points to a fundamental myth about Fannie and Freddie — being allowed to do risky things is the same as being made to do so.

This myth has come up in discussions about their affordable housing goals as well.  When Congress increased these goals, the two companies would buy risky products not because they had to, but because they wanted to keep overall growing market share.  To the extent the goals were expressed as a proportion of their total portfolio, the companies could reduce the purchase of risky loan products by risking the overall size of their portfolios.  But no one ever considers this to be a legitimate option — of course growth is more important than managing credit risk!

More on this complaint anon.

Risky Business Model for Homeowners?

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The Mortgage Bankers Association issued a report, Up-Front Risk Sharing: Ensuring Private Capital Delivers for Consumers, intended to increase the role of the private sector in the portion of the mortgage market currently dominated by Fannie Mae and Freddie Mac.  The MBA argues that to “entice private capital into the mortgage market, FHFA should require the GSEs to offer risk sharing options to lenders at the “point of sale.” (1) The report notes that about “60 percent of new mortgage originations today are sold to the GSEs. This dynamic means that the GSEs’ credit pricing has effectively determined the cost of and access to credit for a wide majority of all new loans.” (5) The GSEs’ credit pricing is thus not set by the market.  The report continues, the GSEs

are now charging more than twice as much in guarantee fees as they did a few years ago, at the same time their acquisition profile shows they are taking on very little credit risk, even compared to pre-bubble credit standards. For example, average credit scores for GSE mortgage purchases prior to the crisis were about 720; today they are 760. Similarly, the weighted average LTV of loans outside of the HARP program are in the high 60% range, several percentage points lower than in the early 2000s. With this combination of high fees and ultra conservative underwriting, it is not surprising that the GSEs are seeing large, indeed record, profits — their revenues are up and their costs are down, not through their execution, but through government fiat and a privileged market position. (2)

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Without quibbling with some of these characterizations, I would note that I have long taken the position that the private sector should bear more of the risk of credit loss in the residential mortgage market. As a result, I welcome proposals for them to do so.  This particular proposal also reduces the role of the GSEs which, while just a partial reduction, is another welcome development.  So, this proposal appears to be good for the mortgage industry (particularly private mortgage insurers).  It is also good for taxpayers because the private sector would be taking on credit risk from the federal government.

The question that remains is whether this is the right solution for homeowners.  The MBA says that this proposal will increase access to credit.  It would be helpful if the industry could model this claim.  The lending industry has its own cycle of credit loosening and tightening, so it would make sense to understand how such a cycle would impact homeowners if we moved toward such a system and moved away from the Fannie/Freddie duopoly.