Tag Archives: government-sponsored enterprise

Fannie/Freddie 2016 Scorecard

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Anne Madsen

The Federal Housing Finance Agency has posted the 2016 Scorecard for Fannie Mae, Freddie Mac, and Common Securitization Solutions. The FHFA assesses the three entities using the following criteria, among others:

  • The extent to which each Enterprise conducts initiatives in a safe and sound manner consistent with FHFA’s expectations for all activities;
  • The extent to which the outcomes of their activities support a competitive and resilient secondary mortgage market to support homeowners and renters . . . (2)

The FHFA expects Fannie and Freddie to “Maintain, in a Safe and Sound Manner, Credit Availability and Foreclosure Prevention Activities for New and Refinanced Mortgages to Foster Liquid, Efficient, Competitive, and Resilient National Housing Finance Markets.” (3) The specifics are, unfortunately, not too specific when it comes to big picture issues like maintaining credit availability in a safe and sound manner, although the scorecard does discuss particular programs and policies like the Reps and Warranties Framework and the expiration of HAMP and HARP.

The FHFA also expects Fannie and Freddie to “Reduce Taxpayer Risk Through Increasing the Role of Private Capital in the Mortgage Market.” Here, the FHFA has more specifics, as it outlines particular risk transfer objects, such as requiring the Enterprises to transfer “credit risk on at least 90 percent of the unpaid principal balance of newly acquired single-family mortgages in” certain loan categories. (5)

The last goals relate to the building of the Common Securitization Platform and Single Security: Fannie and Freddie are to “Build a New Single-Family Infrastructure for Use by the Enterprises and Adaptable for Use by Other Participants in the Secondary Market in the Future.” (7) The FHFA us moving with all deliberate speed to reshape the secondary mortgage market in the face of indifference or gridlock in Congress.

The FHFA may implement the reform of Fannie and Freddie all by its lonesome. Maybe that’s the best result, given where Congress is these days.

 

Fannie, Freddie & The Affordable Housing Feint

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Robert J. Shapiro

kamarck_mm_duo

Elaine C. Kamarck

 

 

 

 

 

Robert J. Shapiro and Elaine C. Kamarck have posted A Strategy to Promote Affordable Housing for All Americans By Recapitalizing Fannie Mae and Freddie Mac. While it presents as a plan to fund affordable housing, the biggest winners would be speculators who bought up shares of Fannie and Freddie stock and who may end up with nothing if a plan like this is not adopted.  The Executive Summary states that

This study presents a strategy for ending the current conservatorship and majority government ownership of Fannie and Freddie in a way that will enable them, once again, to effectively promote greater homeownership by average Americans and greater access to affordable housing by low-income households. This strategy includes regulation of both enterprises to prevent a recurrence of their effective insolvency in 2008 and the associated bailouts, including 4.0% capital reserves, regular financial monitoring, examinations and risk assessments by the Federal Housing Finance Agency (FHFA), as dictated by HERA. Notably, an internal Treasury analysis in 2011 recommended capital requirements, consistent with the Basel III accords, of 3.0% to 4.0%. In addition, the President should name a substantial share of the boards of both enterprises, to act as public interest directors. The strategy has four basic elements to ensure that Fannie and Freddie can rebuild the capital required to responsibly carry out their basic missions, absorb losses from future housing downturns, and expand their efforts to support access to affordable housing for all households:

  • In recognition of Fannie and Freddie’s repayments to the Treasury of $239 billion, some $50 billion more than they received in bailout payments, the Treasury would write off any remaining balance owed by the enterprises under the “Preferred Stock Purchase Agreements” (PSPAs).
  • The Treasury also would end its quarterly claim or “sweep” of the profits earned by Fannie and Freddie, so their future retained earnings can be used to build their capital reserves.
  • Fannie and Freddie also should raise roughly $100 billion in additional capital through several rounds of new common stock sales into the market.
  • The Treasury should transfer its warrants for 79.9% of Fannie and Freddie’s current common shares to the HTF [Housing Trust Fund] and the CMF [Capital Magnet Fund], which could sell the shares in a series of secondary stock offerings and use the proceeds, estimated at $100 billion, to endow their efforts to expand access to affordable housing for even very low-income households.

Under this strategy, Fannie and Freddie could once again ensure the liquidity and stability of U.S. housing markets, under prudent financial constraints and less exposure to the risks of mortgage defaults. The strategy would dilute the common shares holdings of current private investors from 20% to 10%, while increasing their value as Fannie and Freddie restore and claim their profitability. Finally, the strategy would establish very substantial support through the HTF and CPM for state programs that increase access to affordable rental housing by very low-income American and affordable home ownership by low-to-moderate income households.

Wow — there is a lot that is very bad about this plan.  Where to begin? First, we would return to the same public/private hybrid model for Fannie and Freddie that got us into so much trouble to begin with.

Second, it would it would reward speculators in Fannie and Freddie stock. That is not terrible in itself, but the question would be — why would you want to? The reason given here would be to put a massive amount of money into affordable housing. That seems like a good rationale, until you realize that that money would just be an accounting move from one federal government account to another. It does not expand the pie, it just makes one slice bigger and one slice smaller. This is a good way to get buy-in from some constituencies in the housing industry, but from a broader public policy perspective, it is just a shuffling around of resources.

There’s more to say, but this blog post has gone on long enough. Fannie and Freddie need to be reformed, but this is not the way to do it.

 

The End of Private-Label Securities?

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Steve Jurvetson

Jamie Dimon, CEO of JPMorgan Chase

J.P. Morgan’s Securitized Products Weekly has a report, Proposed FRTB Ruling Endangers ABS, CMBS and Non-Agency RMBS Markets. This is one of those technical studies that have a lot of real world relevance to those of us concerned about the housing markets more generally.

The report analyzes proposed capital rules contained in the Fundamental Review of the Trading Book (FRTB). JPMorgan believes that these proposed rules would make the secondary trading in residential mortgage-backed securities unprofitable. It also believes that “there is no sector that escapes unscathed; capital will rise dramatically across all securitized product sectors, except agency MBS.” (1) It concludes that “[u]ltimately, in its current form, the FRTB would damage the availability of credit to consumers, reduce lending activity in the form of commercial mortgage and set back private securitization, entrenching the GSEs as the primary securitization vehicle in the residential mortgage market.” (1)

JPMorgan finds that the the impact of these proposed regulations on non-agency residential-mortgage backed securities (jumbos and otherwise) “is so onerous that we wonder if this was the actual intent of the regulators.” Without getting too technical, the authors thought “that the regulators simply had a mathematical mistake in their calculation (and were off by a factor of 100, but unfortunately this is what was intended.” (4) Because these capital rules “would make it highly unattractive for dealers to hold inventory in non-agency securities,” JPMorgan believes that they threaten the entire non-agency RMBS market. (5)

The report concludes with a policy takeaway:

Policymakers have at various times advocated for GSE reform in which the private sector (and private capital) would play a larger role. However, with such high capital requirements under the proposal — compared with capital advantages for GSE securities and a negligible amount of capital for the GSEs themselves — we believe this proposal would significantly set back private securitization, entrenching the GSEs as the primary securitization vehicle in the mortgage market. (5, emphasis removed)

I am not aware if JPMorgan’s concerns are broadly held, so it would important to hear others weigh in on this topic.

If the proposed rule is adopted, it is likely not to be implemented for a few years.  As a result, there is plenty of time to get the right balance between safety and soundness on the one hand and credit availability on the other. While the private-label sector has been a source of trouble in the past, particularly during the subprime boom, it is not in the public interest to put an end to it:  it has provided capital to the jumbo sector and provides much needed competition to Fannie, Freddie and Ginnie.

Credit Risk Transfer Deals

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A Syn

The Federal Housing Finance Agency released an Overview of Fannie Mae and Freddie Mac Credit Risk Transfer Transactions. It opens,

In 2012, the Federal Housing Finance Agency (FHFA) initiated a strategic plan to develop a program of credit risk transfer intended to reduce Fannie Mae’s and Freddie Mac’s (the Enterprises’) overall risk and, therefore, the risk they pose to taxpayers. In just three years, the Enterprises have made significant progress in developing a market for credit risk transfer securities, evidenced by the fact that they have already transferred significant credit risk on loans with over $667 billion of unpaid principal balance (UPB).

Credit risk transfer is now a regular part of the Enterprises’ business. The Enterprises are currently transferring a significant amount of the credit risk on almost 90% of the loans that account for the vast majority of their underlying credit risk. These loans constitute about half of all Enterprise loan acquisitions. Going forward, FHFA will continue to encourage the Enterprises to engage in large volumes of meaningful credit risk transfer through specific goals in the annual conservatorship scorecard and by working closely with Enterprise staff to develop and evaluate credit risk transfer structures. (2)

This is indeed good news for taxpayers and should reduce their exposure to future losses at Fannie and Freddie. There is still a lot of work to do, though, to get that risk level as low as possible. The report notes that these transactions have not yet been done for adjustable-rate mortgages or 15 year mortgages. Most importantly, the report cautions that

Because the programs have not been implemented through an entire housing price cycle, it is too soon to say whether the credit risk transfer transactions currently ongoing will make economic sense in all stages of the cycle. Specifically, we cannot know the extent to which investors will continue to participate through a housing downturn. Additionally, the investor base and pricing for these transactions could be affected by a higher interest rate environment in which other fixed-income securities may be more attractive alternatives. (22)

Taxpayers are exposed to many heightened risks during Fannie and Freddie’s conservatorship, such as operational risk. These risk transfer transactions are thus particularly important while the two companies linger on in that state.

Principal-ed Reduction

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Torn Dollar

 

The Urban Institute’s Housing Finance Policy Center has issued a report, Principal Reduction and the GSEs: The Moment for a Big Impact Has Passed. It opens,

The Federal Housing Finance Agency (FHFA) prohibits Fannie Mae and Freddie Mac (the government-sponsored enterprises, or GSEs) from unilaterally reducing the principal balance of loans that they guarantee, known as principal reduction. When director Ed DeMarco established the prohibition, he was concerned that reducing principal would cost the GSEs too much, not only in setting up the systems required to implement it, but also— and to him more important — in encouraging borrowers to default in order to receive the benefit. DeMarco’s position generated significant controversy, as advocates viewed principal reduction as a critical tool for reducing borrower distress and pointed out that the program the Obama administration had put forward to provide the relief had largely eliminated the cost to the GSEs, including the moral hazard. We believe that at the time the advocates had the better side of the argument.

The FHFA is now revisiting that prohibition, though in a very different economic environment than the one faced by Director DeMarco. Home prices are up 35.4 percent since the trough in 2011, adding $5 trillion in home equity and reducing the number of underwater homeowners from a peak of 25 percent to 10 percent. This means that far fewer borrowers would likely benefit under a GSE principal reduction program today. (1, footnote omitted)

Principal reduction was highly disfavored at the start of the financial crisis as it was perceived as a sort of giveaway to irresponsible borrowers. Some academics have disputed this characterization, but it probably remains a political reality.

In any event, I think this report has the analysis of the current situation right — the time for principal reduction has passed. But it is worth considering the conditions under which it might be appropriate in the future (for that next crisis, or the one after that). The authors make four  assumptions for a politically feasible principal reduction program:

  1. borrowers must be delinquent at the time the program is announced, in order to avoid the moral hazard of encouraging borrowers to default;
  2. borrowers must be underwater;
  3. the house must be owner-occupied; and
  4. the principal reduction is in the economic interest of Fannie and Freddie.

It is worth noting that during the Great Depression, the federal government figured out ways to reduce the burden of rapidly dropping house prices on lenders and borrowers alike without resorting to principal reduction much. Borrowers benefited from longer repayment terms and lower interest rates. Below-market interest rates are similar to principal reduction because they also reduce monthly costs for borrowers. They are also politically more feasible. It would be great to have a Plan B stored away at the FHFA, the FHA and the VA that outlines a systematic response to a nation-wide drop in housing prices. It could involve principal reduction but it does not need to.

Bank Settlements and the Arc of Justice

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Ron Cogswell

MLK Memorial in DC

Martin Luther King, Jr. said that the “arc of the moral universe is long, but it bends towards justice.” A recent report by SNL Financial (available here, but requires a lot of sign-up info) offers us a chance to evaluate that claim in the context of the financial crisis.

SNL reports that the six largest bank holding companies have paid over $132 billion to settle credit crisis and mortgage-related lawsuits brought by governments, investors and other financial institutions.

In the context of the litigation over the Fannie and Freddie conservatorships, I had considered whether it is efficient to respond to financial crises by allowing the government to do what it needs to do during the crisis and then “use litigation to make an accounting to all of the stakeholders once the situation has stabilized.” (121)

Given that the biggest bank settlements are now in the rear view window, we can now say that the accounting for the financial crisis comes in at around $132 billion give or take. Does that number do justice for the wrongs of the boom times?  I don’t think I have my own answer to that question yet, but it is certainly worth considering.

On the one hand, we should acknowledge that it is a humongous number, a number so big that that no one would have considered it a likely one at the beginning of the financial crisis. This crisis made nine and ten digit settlement numbers a routine event.

On the other hand, wrongdoing (along with good old-fashioned boom mentality) during the financial crisis almost sent the global economy into a depression.  It also wreaked havoc on so many individuals, directly and indirectly.

I look forward to seeing metrics that can make sense of this (ratio of settlement amounts to annual profits of Wall Street firms; ratio to bonus pools; ratio to home equity lost), but I will say that I am struck by the lack of individual accountability that has come out of all of this litigation.

Individuals who made six, seven and eight figure paychecks from this wrongdoing were able to move on relatively unscathed.  We should think about how to avoid that result the next time around. Otherwise the arc of justice will bend in the wrong direction.

 

Mortgage Credit Conditions Easing

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Home of Easy Credit

The Urban Institute’s Housing Finance Policy Center has released its July Housing Finance at a Glance. It opens,

Our latest update to HFPC’s Credit Availability Index (HCAI) shows early signs that the overly tight mortgage lending standards of the post-crisis period may finally be starting to ease. This HCAI update shows improvements for both GSE and FHA/VA channels. Between Q3 2013 and Q1 2015, the expected mortgage default rate increased from 1.8 to 2.1 percent (17 percent increase) for GSE originations, and from 9.6 to 10.8 percent (a 13 percent increase) for FHA/VA originations. The expected default rate for portfolio loans and PLS channels has remained largely flat at 2.6 percent over this period.

Long overdue, these improvements are largely a result of efforts to clarify put-back standards and conduct early due diligence. While the FHA has lagged the GSEs in these efforts, it has made some progress. Still, more needs to be done, especially to mitigate uncertain lender litigation risk arising out of FHA’s False Claims Act.

These improvements notwithstanding, there is still significant room to safely expand the credit box. Even if the mortgage market had taken twice the default risk it took in Q1 2015, that level would have still been below the level of default risk of the early 2000s. (3)

This excellent chartbook contains many very interesting graphs. I recommend that you look at the National Housing Affordability Over Time graph in particular. It shows that housing “prices are still very affordable by historical standards, despite increases over the last three years.” (16)