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Next Steps for Fannie and Freddie

December 23, 2009

Next Steps for Fannie and Freddie

The Financial Times today published a summary piece on what’s likely to happen next to Fannie Mae and Freddie Mac.  The Obama Administration has committed to laying out options in its February, 2010 budget submission.  But the folks responsible for producing them may rue this promise made earlier in 2009 when the rest of the Administration’s financial modernization package was unveiled.

The government’s unprecedented and aggressive support for the mortgage markets hinges almost entirely on the continued role the two companies play in the market.  The private securitization market is dead.  Recent research from JP Morgan suggests that it will remain that way from some time to come.

The Federal Reserve’s $1.25 trillion purchase program for Fannie and Freddie MBS is supposed to wind down in the first quarter of 2010.  But many observers doubt they will be able to do so in the face of likely political opposition to moves that could raise interest rates for consumers, as phasing out the program might do.

The two companies also are playing a crucial role in administering the Administration’s “Making Home Affordable” mortgage modification program.  Once restructured, it isn’t clear how that capacity could be easily replicated.

Perhaps because they were the first crippled financial patients to go under the knife in 2008, the terms of their government assistance are significantly more onerous than those that Bank of America and other major lenders had to agree to.  The dividend on the preferred stock held by Treasury in return for its investments in the two companies—now totaling $112 billion—is 10 percent, for instance, higher than that imposed on other bailees.  Neither company is likely to be able to pay back what they owe, in addition to their dividend payments, anytime soon.

It can be argued that the government has the two companies exactly where it wants them:  firmly under government control, but not on the government’s balance sheet.  They can be used to further public policy goals without interference from shareholders or private owners, at a time when the government has few similarly powerful direct levers to work in the economy.

So the question essentially should come down to this:  what is the rush to alter the current structure?  With many trillions of outstanding MBS under their guarantee, and a combined market share exceeding 70 percent now, a great deal of the housing market’s immediate and near future health seems likely to ride on the two companies and the market’s faith in their guarantees on the securities.  And the only way to guarantee that for the moment, it seems, is through the continued support of the current system, however creaky it may be.

The Financial Times piece summarizes a series of potential paths the Administration could choose.  Having spent many hours over the last year with colleagues in the progressive policy sector trying to develop a workable successor model, I’m skeptical of their chances for success in the short run.  I look forward to working with them, and hope that something durable and workable can emerge.  But mostly I’m anxious that politics and theory are not allowed to trump pragmatism when it comes to the question of timing.  Rushing to a solution merely for the sake of having one is not the right path.

$4 Billion in LIHTC Trade-Ins Funded

December 23, 2009

$4 Billion in LIHTC Trade-Ins Funded

The Treasury Department announced on December 22, 2009 that since it has provided just over $4 billion to state and local housing finance agencies under the “tax credit exchange” program adopted as part of the 2008 economic recovery legislation.  Under this program, state  agencies that receive allocations of Low Income Housing Tax Credits (LIHTCs) can exchange up to 40 percent of their allocation and receive 85 percent of the value of the credit in cash. This program was designed to provide direct investment funding where lack of investor interest no longer made the LIHTC mechanism useful for raising equity to invest in affordable rental housing developments.  The complete list of total awards by state can be found on the Treasury’s website.

Are Business Schools Part of the Problem?

December 22, 2009

The New Republic recently published a provocative article exploring to what degree American business schools have fueled the flight of top managerial talent into finance and away from manufacturing.  As the article points out, it’s not a trivial question.  America’s ability to compete with innovators like Toyota certainly has been a key factor in the US automobile industry’s failure.

The article rings true to me.  When I was at the Wharton School of Business’s Advanced Mangement Program in 1997, my class of 47 mostly overseas mid-career executives met twice with second year business school students.  A couple of things really stood out for me.  First, when asked what they were hoping to do when they left Wharton, every single student mentioned investment banking or consulting.  Second, their responses to the question “what are you looking for in your next job” appalled me.  Every one talked about the salary and perks they expected, the amount of travel, and the clear path to the top.  Not one mentioned seeking a place where they could make a difference, or where they could learn a business from the ground up.  Third, when the session broke up and our class processed the evening, I was amazed that every one of my colleagues—most but not all of whom were from manufacturing and operating companies—said they would never hire an MBA unless they’d sent the person there from their own managerial ranks.  Why?  Because their experience with MBA’s from US schools, at least, had been that they were entitled, disinterested in learning how their business operated, and unable to make substantive contributions to the “business of the business.”  And some of these executives themselves had MBAs, one from Wharton.

It is unfair, of course, to characterize all business school students from this small sample. But this article takes a broader look at the same issues and draws some disturbing conclusions.

Making Loan Mods Work

November 29, 2009

The New York Times this weekend reported that the Obama Administration is likely to announce new measures to help beleaguered homeowners stave off foreclosure. Although more than 600,000 owners are in trial modifications under the Making Home Affordable program announced last March, only a few thousand have received final modifications. Trial periods that were meant to last 3 months have been extended to 5 as a result. The performance of servicers varies widely among the 35 who signed up with the Treasury to use the program with the borrowers in their portfolios. Advocates for homeowners and Congress are frustrated with the slow pace and urging more action.

It’s unclear what new measures the Administration might take.  But the weekend’s report comes on the heel of another Times report describing how hedge funds and other investors are profiting from the ongoing crisis by buying distressed mortgages at a discount, refinancing them at a much lower principal amount made possible by their discounted purchase and splitting the difference with current borrowers.  The article details how Fortress Investment Group - ironically headed by former Fannie Mae CEO Daniel H. Mudd -  and other investors are managing to reduce borrower principal by significant amounts while still turning a profit.  There are only limited opportunities to reduce principal under Making Home Affordable; the interest reduction approach that is its chief tool can lower monthly payments but does nothing to reduce the outstanding debt.

The investors’ scheme is clever.  The Obama Administration was advised to follow a similar course in February, 2009, in a policy paper prepared for HUD Secretary Shaun S. Donovan under the auspices of the University of Pennsylvania’s Institute for Urban Research.  Bart Harvey and I co-lead the task force that produced the paper.  We urged the government to buy distressed mortgages directly at a steep discount and then centrally organize the restructuring or dissolution of these debts.  We argued that this would accelerate the process and allow the government to organize effective modifications designed for long-term stability.

But the Making Home Affordable plan instead relies on incentive payments to existing servicers to encourage them to effectively re-underwrite the loans.  It relies on a calculation of “net present value” of the current home that is not transparent and does not seem to adequately account for differences in current values within and between metropolitan areas.  It relies on 35 different servicers all designing new systems for accepting applications, reviewing them, tracking them, and evaluating them.  This has meant hiring thousands of processors who must be trained, and building technology systems that take time and money to design and execute.

Since its inception borrowers have had to put up with faxed applications, frequently lost documents and resubmissions, and opaque decisions.  Some owners even have found themselves facing foreclosure evictions while awaiting approval of their applications or while in trial modifications.  This is either because the servicers’ systems aren’t robust enough to connect the foreclosure and modification operations effectively or servicers stand to earn more through continuing foreclosures even though it is prohibited in their contracts under Making Home Affordable.  Whatever the reasons for these frustrations and failures, the result is anxiety for homeowners and failure to deliver on the program’s promise.

Despite the obstacles and start up delays, Treasury reports show that more than 600,000 trial modifications have been put in place.  Treasury Assistant Secretary Herbert M. Allison told a group of advocates last week that the pace of permanent modifications is lagging way behind expectations.  The department’s focus over the next six weeks will be on moving those numbers up, he said.  But he also reminded the group that servicers entered into the program voluntarily, and the government has only limited options to force action.

Meanwhile, the private investment schemes may end up leaving the government holding the bag in the end anyway, because virtually all new mortgage lending today is backed one way or another by Uncle Sam.  FHA today is the only route for low downpayment borrowers.  If the same borrowers get into trouble on their new loans, it will be FHA that has to pay off the lender and will be stuck with the loans.  If the borrowers have the scratch for a larger downpayment, their loans are likely to be bundled into securities by Fannie Mae and Freddie Mac, and the bonds purchased by the Fed.  If they go bad, taxpayers could end up footing at least part of the bill.

It would have been much simpler and more direct for the government to move aggressively to purchase distressed loans at steep discounts earlier this year.  It could have contracted for the servicing workouts under closer supervision.  It could have offered lenient terms to forestall foreclosures and the havoc they are wreaking in communities.  Making Home Affordable was an important step forward, but its limitations are becoming clearer with time.  The new initiatives anticipated on Monday (November 30, 2009) hopefully will accelerate success.

Remembering Jack Kemp

August 03, 2009

In 1989, when I was President of the National Low Income Housing Coalition, I had the privilege to chair the national steering committee for Housing Now!, a mass mobilization on behalf of the homeless created and driven by the late Mitch Snyder.  Months of grassroots organizing cuminated in a two day program of meeting and demonstrations climaxing on October 7 with a huge rally on the National Mall.  Crowd estimates ranged as high as 250,000 and more.

The day before the rally, I led a group of participants to a meeting at HUD.  The decision to seek a meeting was controversial; one steering committee likened it to “Captain Ahab asking for a meeting with Moby Dick.”  But we did request a meeting with HUD Secretary Jack Kemp, and he agreed.

The HUD building was surrounded by police in riot gear.  It was ringed with security barriers and checkpoints.  I don’t know what they were expecting, but they were prepared for the worst.  My little group included some homeless advocates whose plans for the day included possibly occupying the HUD building.  Before we entered the building we huddled and got everyone to agree to leave when our meeting was over, but this illustrated the mood folks were in.  Homelessness had become a flashpoint issue in the Bush I presidency.  Snyder had skillfully enlisted media, entertainment figures, and politicos in support of his cause and Housing Now!  Hurricane Hugo had ripped through some of the convoys of homeless people walking and riding to the demonstration.  Folks were not in a forgiving mood.

We’d been scheduled for a half-hour.  We were escorted up to the tenth floor of HUD to the Secretary’s office.  The staff was keeping a close eye on us.  Our group included folks who had spent most of their recent nights sleeping in shelters or in the streets.  It was not your typical HUD visit.

When we arrived in his conference room, Jack Kemp got up and walked over to each of us, stuck out his hand and in his unmistakable gravelly voice said “Hi, my name is Jack Kemp, welcome to HUD.”  The Assistant Secretaries for Housing and for Community Planning and Development were there.  But it was clear from the start that Kemp was the star of HUD’s team.  He asked each of our group to tell him about themselves.  He engaged each of them in conversation about their lives, why they were homeless, and the reasons they had come.  He told them he thought homelessness was unacceptable and that he was committed to finding solutions. Our 30-minute meeting was turning into something much longer.  Staff came to the conference room and tried to signal Kemp that it was time to wrap it up.  He wasn’t interested.  “It’s getting late,” he observed, “and these people must be getting hungry.  Can I get you all some lunch?”  And sandwiches were delivered from the HUD cafeteria.

Before we were done,  2 hours or so after we’d arrived, the most hardened advocates in the group were engaged in deep conversations with Kemp, who treated each of them like a human being and showed them respect and consideration.  Our objective was to get a statement from Kemp supporting Housing Now!‘s demands.  None of the advocates expected to leave with anything but another club to beat the Bush Administration with.  Kemp first responded that “you can take my word…I’m going to do everything I can.”  He even turned to me, and said, “Zigas, you know me, tell them that my word is good.”  For some reason, he always called me Zigas, and in later years I took to calling him “Kemp.”  I demurred and said we were representing a lot of folks, and this group needed to come back with something tangible.  Kemp thought a minute, then said “you and Austin (Fitts, AS for Housing) and Anna (Kondratis, AS for Community Development) go off and draft something up.”  We did, while he remained with the others, telling and listening to stories.

I don’t know who was more reluctant to leave that conference room, Kemp or the homeless folks.  When we emerged on the plaza in front of HUD and read out Kemp’s letter, the assembled crowd was first stunned, then jubilant.

So I was saddened to hear of Jack Kemp’s death from cancer earlier this summer.  We had opportunities to meet and work together through the rest of his tenure, and after.  I didn’t agree with a lot of his views, and I thought he failed to make the kind of difference he aspired to while HUD Secretary.  He was marginalized by the President and Cabinet.  But I never got over his immediate ability to connect with those homeless people.  Or his vocal and energetic commitment to racial equality and a better life for all people.  We disagreed over the means, but not the end.

American politics have become so poisoned by unrelenting partisanship that it’s hard to remember when Republican Jack Kemp welcomed incoming Democrat Henry C. Cisneros to the HUD building in 1993.  He presented him with a bust of Lincoln in front of a town hall meeting of HUD employees, praising his background and credentials, and urging HUD employees to help him succeed.  Kemp and Cisneros teamed up then and later on a series of efforts, and Kemp stood out more and more as time went on and his party colleagues veered further and further from his generous stance.

I’ll miss his gravelly voice, his sometimes off-beat views on gold and other things.  But most of all I’ll miss how he represented many of the best qualities of a politician who came to Washington to serve.