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Where Has All The Money Gone?
July 15, 2008
It will take years to sift through the mortgage market's wreckage before we know all the details behind its collapse. But public policy can't wait that long to draw some conclusions about the role played by low down payment home loans to people of modest means. This is of particular importance to federal bank regulators, who are responsible for enforcing the Community Reinvestment Act (CRA), and to whoever turns out to be the regulator for Fannie Mae and Freddie Mac with authority over their housing goals.
Plenty of commentators have suggested in the last year that more aggressive lending to people with lower credit profiles and little or no money to put down are drivers of the crisis. But at least two sources of information suggest that while these borrowers' performance has been poorer lately than in prior periods, it was other types of lending to different types of borrowers that is putting the hurt on lenders, investors and guarantors.
Fannie Mae built one of the largest portfolios of community lending assets in the country in the last 20 years. Starting with its Community Home Buyers© products offering the first standardized 5 percent and later 3 percent down payment products, the company expanded and tweaked these products until it incorporated its My Community Mortgage© product into its Desktop Underwriter© automated underwriting software in 2006. From 1996 until 2006 I oversaw much of the development work on these products.
In 1998, Fannie Mae joined with the Ford Foundation and the Self Help Ventures Fund to launch the Community Access Program, an owner-occupant mortgage lending partnership aimed specifically at low-and moderate income, low wealth households. Ford also funded a separate ongoing research effort at the Center for Community Capital at the University of North Carolina to provide a rigorous evaluation as the program evolved.
In a presentation prepared for a Neighborworks America symposium in Cincinnati in May, 2008, the Center's former director Michael Stegman summarized some of the ongoing research's findings on performance of these loans. Comparing their performance from the beginning of the program in 1998 through September, 2007, the UNC research shows that the Community Access loans experienced 90+ day delinquencies (where the borrower fails to pay for at least three months) at rates that were higher than prime fixed rate mortgages, but significantly lower than FHA-insured loans, subprime fixed rate loans and subprime ARM loans. Compared to subprime loans, Community Access loans were significantly slower to show the first 90+ day delinquencies than either fixed or adjustable subprime loans, and in later years of the program significantly slower than prime, fixed rate loans. This performance held pretty steady until 2006, when these trends showed a marked deterioration, with the 90 day delinquency rate rising much faster than it had for earlier "vintages," but still significantly better than subprime loans from the same period.
It was assumed at the time these loans were underwritten that they would not perform as well as prime loans, and they did not. Pricing decisions were made on those assumptions, and they seem to have been borne out. What the analysis also shows, however, is that well underwritten loans to people of modest means with low down payments far outperformed subprime loans issued during the same periods.
More Data
The other interesting source of information about loan performance is Fannie Mae's quarterly investor information summaries, the latest of which was released in May, 2008. One table in particular, titled "Fannie Mae Credit Profile by Key Product Features (page 24 in the linked file), offers some tantalizing insights into Fannie Mae's losses.
The table does not allow a direct evaluation of the company's community lending products. It only offers partial slices of data. So, for instance, the table shows that the company has a total single family credit book of $2.606 trillion, and within that a $128.1 billion credit exposure to loans with credit scores below 620 (the usual cut off before moving into subprime borrower territory, and the cut off for any loans under the My Community Mortgage© product). This was 4.9 percent of the total credit exposure, but accounted for 14 percent of the credit losses in the first quarter of 2008. That's a multiple of slightly less than 3...not good, but certainly not enough to blow them up with such a relatively small base.
Similarly, the table shows that Fannie had $258.6 billion in loans with down payments of less than 10 percent. That was 10.3 percent of the credit book, but accounted for 17.4 percent of the first quarter credit losses. That's a multiple of about 1.7.
Loans with credit scores below 620 and less than 10 percent down accounted for $30 billion, or 1.2 percent of the credit book, but 6 percent of first quarter credit losses. That's a multiple of 5. This is not too surprising when you combine crummy credit histories with low down payments.
So far the story seems to be that loans at the "tail ends" of the credit spectrum are doing more poorly than their share of the total would suggest.
Liar, Liar, Loan's on Fire!
But the table also accounts for Alt-A and subprime loans. The latter made up a very small piece of the credit book, only $8 billion, or 0.3 percent of the book, and 1.4 percent of the losses. Around a multiple of 4, but a very small nominal amount.
Alt-A, on the other hand, accounted for $310.5 billion, or 11.2 percent of the total credit book of $2.6 trillion, but....wait for it....42.7 percent of first quarter credit losses. That's a multiple of nearly 4 on a helluva base. Compare this to the low downpayment loans - 10 percent of the credit book, but only 17.4 percent of the losses.
Alt-A loans were supposedly made to people with good credit but with special flexibilities, like income that was reported but not verified, or no stated assets, and so on. They seldom had mortgage insurance (only 40 percent did, according to this table, compared to 92.7 percent of those with less than 10 percent down), which means Fannie Mae is much more exposed to losses from these loans. They also tended to be much higher balance loans, often were accompanied by separate second mortgages from other lenders that actually drove up the overall LTV, and were concentrated in states with rapidly escalating and now falling home prices.
These loans have become known in the industry as "liar loans." As in, lied about income, lied about assets. Bankers forgot a key principle of the Reagan era - trust, but verify. The cratering performance of these loans is one result.
Fannie Mae's table doesn't analyze the loans by exclusive category; many loans fit into more than one. Low credit score and low down payment loan numbers are partially or fully included in the Alt-A numbers, and vice versa, so comparing the ratios is not totally apples to apples.
A Little Knowledge...
These numbers are tantalizing, but ultimately frustrating, because they still do not allow a reliable analysis of how the products most specifically targeted to low wealth, low income borrowers are performing and what share of Fannie Mae's losses they account for.
Likewise, there is no public information available to analyze the performance of billions of dollars of specialized loan products that regulated banks put on their books to help them comply with Community Reinvestment Act (CRA) requirements.
My colleague and former Fannie Mae-er Ellen Seidman has disposed handily of suggestions that CRA is the root cause of the mortgage market's meltdown. I support her analysis 100 percent. But all of the contextual facts still do not answer the very important question of how the loans made to satisfy CRA requirements - or for Fannie Mae, their legislative housing goals - actually are performing and what lessons regulators, lenders and advocates should be learning from the last 20 years' experience.
There are no published data from banks about their loan performance, just as there is scarce product line information from Fannie Mae and Freddie Mac. It would be in the regulators' and the public's best interests to find a way to get this information from the lending community in order to shape the regulatory environment based on actual facts rather than self-serving or uninformed assertions. OFHEO could do this analysis on Fannie and Freddie's books. The OCC and the Fed could do it for regulated banks.
For the long term, what's puzzling and sobering is that having invested so much time and effort in these initiatives, regulators and industry have so little information about the performance of these loans. Fixing that gap would be a good goal for the next Administration.
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Get Me Rewrite!
July 14, 2008
Among all the depressing lowlights of last week's stock run on Fannie Mae and Freddie Mac, the terrible quality of the coverage by nearly every outlet I encountered rates right at the top. Because I remain a Fannie Mae shareholder, I tried to follow this pretty closely. I even watched some cable financial news coverage, something I never do, and I hopped through Google and Yahoo Finance hourly.
Night after night, morning after morning, news outlets focused on the two GSEs, and not in a good way. Rightfully so, because it was a big story: two Fortune 500 companies that have become practically the only source of mortgage credit suffer staggering losses in their stocks, costing shareholders tens of billions of dollars and conceivably crippling both companies.
But why did this happen? What drove investors to rush out of these stocks?
Got Any Facts?
If you were a common investor with only a rudimentary understanding of these companies and relied on the mainstream media for information, the message went something like this: Fannie and Freddie are finally being held to account; decades of subterfuge and political management have finally yielded to an informed marketplace that realizes the two companies are in such terrible trouble only stupid investors are going to hold onto the stock; the two Washington, D.C.-based emperors of housing finance have no clothes; this is like Bear, Stearns all over again and the companies are facing insolvency; the federal government is going to have to take them over, taxpayers are about to take it in the kishkes.
Over the weekend the press hyped the story further and borrowed from their sports divisions by painting Freddie Mac's planned Monday(July 14, 2008) debt sale as a capital markets death match on which the health of the US economy hinged. These stories typically did not point out that Fannie Mae had only days before handled a similar issuance without a hitch, and at a lower cost than one they had held the week before. Such facts might have diluted the dramatic quality of the coverage, I guess. As it turned out, Freddie went to market on Monday without any problems.
The press never explained what caused the rout. Indeed, it seemed almost disinterested in the underlying dynamics. Was it a profound and sudden shift in the company's fundamentals? Had either one suddenly found itself cut off from the debt markets that are essential to fueling their day to day purchase and securitization of mortgages? Were either one in imminent danger of failing their statutorily set minimum capital amounts?
If you consulted some investor reports, read the latter day statements from Treasury Secretary Paulson, or the GSEs' regulator James Lockhart of OFHEO, the answers to these important questions appeared to be...no, no and no.
Late in the week the two companies belatedly released statements confirming this. They pointed out that their debt costs had actually declined in the prior week. They noted that their most recent debt issuances were oversubscribed. They emphasized that they were in compliance with all regulatory capital requirements, and had tens of billions of capital on hand.
Even the Lehman report on a new FASB accounting rule that sparked the rout by noting the rule could conceivably require Fannie and Freddie to dramatically increase their capital to account for assets now held off their balance sheets noted this was a remote possibility, and OFHEO Director Lockhart quickly dismissed the speculation as unfounded.
So what caused the run? Why were investors fleeing the stock? Inquiring minds want to know.
Good News is No News?
News outlets did endlessly note that the two own or securitize more than 70 percent of current originations, but then moved on without much insight. If you looked hard, you could find an isolated reference or two to the fact that these assets are being booked at much higher fees than in the past, and that tightened underwriting means these will be of higher quality than older loans.
In other words, here are two companies whose regulator says that they are not suffering a liquidity crisis; that have adequate capital; that currently own their markets outright and are booking enormous amounts of new business; that have been able to increase fees that will provide income flow for years to come; and that have increased the quality of those assets and thus the likelihood that the higher income streams will be there in the future.
So with these fundamentals in place, why would their stocks lose more than half their value in a few short days? Believe me, I am dying to know.
It would have been nice to have found a mainstream media story that actually pondered these issues and illuminated them. But instead the public was treated to a lot of information but little insight.
The New York Times' Sunday news coverage of the affair amounted to little more than a rehash of old stories and quotes from long-time critics.
Jim Cramer was highlighted on endless loops of video declaring both companies dead. He was never pressed to explain exactly why or how. But he must have been delighted to have his opportunity to look glum and declare the need to nationalize both companies.
On Kudlow and Company on Thursday evening, the final word came from a commenter who asserted that the week's lesson was that Fannie and Freddie have been "crowding out" banks and it's high time they were pushed aside to allow the free market to work. Never mind that there isn't a bank on earth today that will make a mortgage loan in the US that it does not believe Fannie or Freddie will ultimately invest in or securitize.
This is what passes for informed commentary.
Sunday (July 13, 2008) evening's White House announcement of special steps the government is prepared to make seem to have calmed the market. But the question that remains unanswered by mainstream press coverage still remains, why did the market dump these stocks in spite of all these facts?
Maybe there are underlying, terrible facts about the GSEs' balance sheets or management that will yet come to light and justify the vaporization of so much market value. As a shareholder I certainly hope not, but if it is I'd rather know why the end is near than be treated to mere assertions that this is so.
But maybe instead we'll learn this was an old fashioned run on two stocks driven by short sellers and panicked sellers, abetted by a press corps that would rather cover the race than uncover the facts. Perhaps not coincidentally, the SEC over the weekend announced a new probe into the use of falsehoods and rumors to manipulate stock prices. It will be interesting to see how the press covers that.
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What Hath Dodd Wrought?
July 14, 2008
The comprehensive foreclosure relief and GSE reform bill has finally passed the U.S. Senate, after an embarrassingly long floor debate. It now heads for an inevitable conference with the House over differences in several areas. And the White Houses's 11th hour request on July 12 to add new authorities to back up Fannie Mae and Freddie Mac promises to make the final discussions even more stressful.
It's ironic, then, that one of the centerpieces of the new legislation in both houses is the establishment of an "affordable housing fund" to be financed through a new tax on the two GSEs.
The so-called "Housing Trust Fund" established by the Senate's Federal Housing Finance Regulatory Reform Act of 2008 would require 4.2 basis points of both Fannie Mae's and Freddie Mac's new business to be diverted into a fund. The idea to require both Fannie and Freddie to devote a specific amount each year to develop and preserve affordable housing is terrific. Properly structured and designed, such a requirement could force the GSE's into more active and meaningful participation in affordable housing preservation and development. It would leverage the unique position the two companies occupy in the housing finance system.
But the trust fund in both the House and Senate bills instead turns Fannie and Freddie into piggy banks, siphoning off money from their operations to provide cash for others. This is like leaving a high powered luxury automobile parked in the back yard to use as extra seating for barbecues.
The Senate bill adds insult to injury by requiring the funds in the first year after authorization to be devoted to paying the costs of a new FHA mortgage insurance scheme designed to help struggling homeowners escape crappy subprime mortgages. Instead of bringing the substantial power and expertise of the GSEs to create new value for residents and communities, the bill turns them into the funders of FHA's full faith and credit guarantees that help subprime lenders unload their soon-to-be-nonperforming loans onto the FHA, where many may fail anyway in spite of better terms.
This is especially ironic considering that the White House now asked Congress to give it the authority to explicitly back Fannie Mae and Freddie Mac.
This perversion of the affordable housing fund idea was promoted by Banking Committee Ranking Member Sen. Richard Shelby (R-AL) and other Republican members. Thus the Senators expressing the most concern over the GSE's ties to the federal government are the ones to make them the FHA's banker!
The House-passed GSE reform bill also establishes a fund. Its version would divert the money first to Hurricane Katrina needs, and then to a "National Affordable Housing Trust Fund" to provide capital for extremely and very low income housing.
Housing advocates cried foul over the Dodd-Shelby "highjacking" of the trust fund. But anyone who thinks this is the last time Congress will find a more compelling use for this money than a dedicated fund for extremely low income housing subsidies is ignoring the totally unbalanced budget and the looming fiscal crisis that is going to make the Donner party look like a polite little buffet dinner among friends.
How did this happen? How did advocates struggling with inadequate funding, growing needs for inventive and sustainable approaches to affordable housing preservation and development, and the opportunity to increase the GSE's relevancy and attention to these issues get sidetracked into a bidding war with every special interest and short-term funding need that comes across Congress's radar screen?
And how did Fannie Mae, in particular, which only 15 years ago was the envy of HUD Secretary Henry Cisneros for its ability to set big goals and bring huge resources to bear on housing problems, find itself cut down to no more than an ATM for every special interest in the housing community? My short list of reasons follows.
Who's your daddy?
Housing advocacy organizations have splintered off into interest sections, whether for trust funds, state housing agency allocations, technical assistance grants, or CDFI capital. There is no unifying, strategic voice within the advocacy community that sees past these important but tactical issues to the larger strategic directions of the housing market.
Thus, Fannie and Freddie become most attractive not for the role they can play in development, but for the cash they can provide to fund other people's priorities.
Sadly, I believe this approach is going to weaken the GSEs' own interest in affordable housing and community development and isolate them further from a strong focus on their missions. It will foster an attitude of "we gave at the office." It will embolden those in the companies who think that the companies' mission is a burden to be endured rather than a calling to be embraced, enhanced and pursued. It is much easier for these companies to write a check than it is for them to actually use economically sustainable strategies to produce and preserve affordable housing.
In addition, advocates' promotion of this new surtax and Congress' willingness to divert it to the crise du jour will reinforce private equity analysts' view that these companies are in eternal danger of having shareholder value siphoned off to meet funding shortfalls for congressional pet projects or causes. This will offer a much more limited upside for investors who provide the capital that makes the GESs' world go ‘round.
Good friends are hard to find
The GSE's have no friends today. How did this happen? After more than 15 years of active cultivation of new partners, sponsorship and partnership of new initiatives and programs, and adopting fundamental and progressive changes in underwriting and financing, why are they so isolated today? When enemies in Congress who adjure the very thought of a government sponsored enterprise layer new, highly restrictive requirements on the companies that would raise their capital and hamstring their ability to innovate, where are the advocates who would benefit from a more active GSE role?
Maybe it's because these companies are complicated, and it's too hard for busy advocates to fully understand. Maybe it's because their real value always has lain in their key importance to the mortgage finance system, rather than to any one part of it, so that no one feels they "own" the issues. Maybe it's because large commercial banks and others who are anxious to strictly limit the GSEs so they can maximize their own participation and profit at consumers' expense are also courting public opinion and have left the GSE's erstwhile friends neutered. Whatever the reason, the lack of strong, strategic and well reasoned advocacy on behalf of the GSEs and their mission is troubling.
Home alone
If the GSE's have no friends willing to speak up for them, maybe it's because of their own alarming unwillingness or inability to speak up for themselves. The transformation of these companies from swaggering buccaneers to shrinking violets is startling.
Fannie Mae's and Freddie Mac's own attempts to forge a trust fund design that would enable them to control the funds and use them to leverage their other investments were hesitant, conflicted, and ultimately too late. In order to avoid aggravating their newly empowered regulator, they have withdrawn into a haze of "no comment" and no self promotion. Humility is a virtue, and it was definitely in short supply during the 1990s and early 2000's.
But an excess of timidity in the pursuit of tranquility is no virtue, to badly paraphrase Barry Goldwater. Maybe there's much more going on behind the scenes than an outsider like I am now can appreciate. But their lack of clear public leadership and advocacy on their own behalf has given their former friends and colleagues a free pass to decamp from the battlefield, as well.
Roll the dice
Because both the House and Senate have cleverly tied the new GSE legislation to a modest rescue package for at-risk homeowners, ultimate passage of these bills into law before the election is a virtual certainty. Others have written with great passion about the new regulatory structure's shortcomings and dangers. Sober analysts might easily conclude that the country is better off waiting for a new Administration before adopting a new regulatory regime. The bitter ideological underpinnings of the Bush Administration's GSE policy might be weakened. A stronger Democratic congressional majority in both houses could make a more reasoned and less vindictive set of policies possible. But I predict hotter heads will prevail. Congress is sick of more than four years of considering these bills. The GSE's seem resigned and more anxious to have this water torture ended than to expend scarce political and regulatory capital on a principled stand.
Advocates will get their "trust fund," minus the funds for now. And the housing community will have missed a major opportunity to reshape the most powerful economic forces in the housing economy into a more progressive and active partner. It's a roll of the dice on an uncertain future. Let's hope it doesn't come up snake eyes.
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Trouble in Paradise
March 16, 2008
Government housing programs have a long history of flaming out shortly after being launched. Rising costs, corruption, scandals, mismanagement and popular opposition have all contributed to an average housing assistance program life span of only about 7 years, according to Charles L. Edson, one of the deans of Washington's assisted housing bar.
So when the Low Income Housing Tax Credit (LIHTC) was adopted in 1986, there was no reason to think it would fare any better.
But the program has not only outlived the average, it has thrived for more than 20 years. It was and remains the only significant federal construction and rehabilitation tool in the federal kit. In return for putting up equity to help build or renovate the affordable rental housing projects, investors get 10 years' worth of tax credits to lower their tax bills. The program is estimated to support as many as 100,000 units per year.
Now, however, it is beset by problems on both the investor and sponsor side. Fannie Mae and Freddie Mac have long been the largest users of the tax credits, accounting for between 30 and 40 percent of demand. Other corporations make up the balance. With real losses from bad loans and investment debts wiping out profits, Fannie, Freddie and others now find themselves with billions in tax credits they cannot use. They are out of the market for the foreseeable future.
On the operations side, rents in tax credit properties are fixed as a percentage of the area's median income. After years of rising every year, these are now falling in many areas. At the same time, energy and other management costs are rising, threatening a widening gap between rental income and expenses.
These two new developments are squeezing the tax credit program from both ends. Whether the program and the existing properties can survive these two challenges may be the most important affordable rental housing question confronting the next Congress and Administration.
Supply and demand drive down yields
The sudden and unprecedented shortage of investors has driven down the price that remaining investors will pay for the credits. Last year, with credits in high demand, some investors were even paying more than a dollar in equity for a dollar in tax credit value. Since inflation makes the future dollar of savings worth less than the present value of the purchase, these prices weren't sustainable. Today, with demand slackening, tax credit prices have fallen to the mid-80 cent range, more in line with historical trends. While this is good news for investors in the credits, it means that the actual capital available for development expenses in the properties has been cut by as much as 20 percent. Development costs have not gone down. So projects are harder to finance when the credits yield less cash. The rents that owners can charge are capped to insure they are affordable to lower income tenants. The difference has to be made up by other assistance, or through developers deferring or surrendering altogether the fees they would normally charge for carrying out the work.
Rents vs Costs
One of my first assignments as a reporter in 1973 was to cover a meeting of sponsors of recently built or rehabilitated apartment projects that had benefited from a 1968 housing program called Section 236. This wildly successful program provided interest rate subsidies to developers in return for restricting rents in the properties. Tens of thousands of apartments were built under the program. But by 1973, oil prices and inflation had decimated the project sponsors. The meeting I attended was in a church. The audience was mostly African-American ministers whose churches were sponsors of Section 236 properties that were going broke because operations expenses were outstripping what they could collect in rents. You could smell the fear in the room; the mood was one step short of full scale panic.
Thirty five years later this scene could be replayed as tax credit projects face a similar crunch. The properties developed in the last 20 years have benefited from steadily, if modestly, rising median incomes and low inflation in energy and other key items. But median income figures compiled by HUD for program sponsors have declined in many markets this year. At the same time, $110 per barrel oil prices are flowing through the projects' income statements. Property owners are potentially facing stagnant or even declining rents at the same time their operating expenses are likely to balloon.
In 1973, the threat of thousands of failing apartments led to project-based Section 8 contracts to subsidize rents, and other adjustments and subsidies to re-balance income and expenses at the property level. The interest rate subsidies could not be increased, and that monthly expense was a fixed cost anyway. It was the volatility of the variable expenses that did in the Section 236 projects.
Tax credit properties could be in for the same experience. The choices facing project sponsors are not easy. There are only a limited number of potential solutions if the trends continue into the future. Rents could be increased. But this would undermine the original purpose of the program, to provide affordable rents to low and very low income tenants. Subsidies could be provided from other sources, like Section 8 or state housing funds. But the credit was negotiated in 1986 to restrict the use of such other subsidies, and these restrictions would have to be lifted. Since housing subsidies are pretty much a zero sum game, this means that other worthy projects would be competing with tax credit properties for scarce funds.
When the tax credits were first created in 1986, advocates and supporters understood its limitations. I was one of the principal advocates and architects of the program, and never thought it was more than an incomplete, and relatively inefficient, solution to the problem of subsidizing supply. But at the time, in the middle of the Reagan Administration's assault on housing subsidies, it was the best we could do. And it significantly improved on existing tax subsidies that were far less effective at targeting benefits to low income renters. The peculiar economic climate of the last 25 years has enabled the program to thrive and to put off the difficult choices now beginning to confront owners and advocates.
It looks as if that long honeymoon may finally be over.