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Please read and comment on the entries that follow.  The most current one will be highlighted on this page; earlier entries can be found under the archives link below.


CFPB Cements Important Mortgage Protections

January 17, 2013

The Consumer Financial Protection Bureau (CFPB) issued new rules on January 10, 2013, putting in place important protections for mortgage borrowers.  The so-called "ability to repay" rule implements provisions of the Dodd-Frank Act that require lenders to underwrite mortgage loans with a reasonable belief that the borrower can repay the loan on the terms at origination.

Seems like common sense, right?  But we learned during the mortgage boom that when regulators fall asleep at the wheel, and lenders are given free rein to compete in a race to the bottom, really bad things happen and common sense is the first thing to go out the window.

I discussed the new rule and its implications for lenders and consumers on Minnesota Public Radio the morning the rules came out.  Enjoy.

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Judge Clears Raines

September 23, 2012

Eight years after leaving Fannie Mae under a cloud of accusations that he manipulated earnings and knowingly violated accounting rules to enrich himself and others at the expense of shareholders, Judge Richard J. Leon of the US District Court for the District of Columbia cleared former Chairman and CEO Frank Raines of the allegations by granting a motion for summary judgment to dismiss the shareholder class action led by the Ohio Public Employees Retirement System and the state's Teachers Retirement System.  In dismissing the suit, Judge Leon wrote that

"There is  not only no direct evidence that Raines intended to deceive Fannie Mae's investors, there is no evidence that he even knew his statements were false....Additionally, plaintiffs fail to offer sufficient evidence to conclude that Raines's statements that they specifically identify as misrepresentations are even false.  Instead, plaintiffs merely carve up Raines's statements to fit their story."

The judge's acerbic and detailed dismissal of the  accusations leveled against Raines -- and in companion suits that have not yet been resolved, against former CFO Timothy Howard and Controller Leanne Spencer -- is a great relief to him, of course.  But it is also to those of us who worked at Fannie Mae when the company's accounting rules were questioned first by our regulator, OFHEO, and later ruled improper by the SEC.  To be clear, those facts are not in dispute:  the company misapplied generally accepted accounting rules in a number of areas.  The resulting earnings restatement cost millions of dollars, upended the company, ended careers, tarnished many reputations, and brought on significant changes in senior leadership, culture and focus within the company.  But the company had made a mistake.  It had to be rectified.  It was.

It's just a shame that the company's mistakes became the center of a feeding frenzy in which the integrity of everyone in the company -- from Frank on down -- was questioned.  Fannie wasn't the only large US company forced to restate earnings because of accounting rules.  It won't be the last.  But the eagerness with which the errors were blamed on deliberate attempts to manipulate earnings stands out.  Many of us spent long evenings trying to explain the intricacies of the actual accounting problems to friends and colleagues.  All of you said you hadn't heard them in the media.  Some of you were gracious and accepted that the errors were real, but the motivations ascribed to Frank and others were not.  Many others simply dismissed the explanations and concluded the worst about Frank and the company.

Leon writes in his decision that 

"At bottom, plaintiffs make much ado about earnings management, but plaintiffs present no evidence that Raines was ever aware that these transactions may have violated GAAP or, more importantly, were being used for an improper purpose....plaintiffs have not identified any evidence that Raines knew or, indeed, had any reason to know, that Fannie Mae's accounting violated GAAP. Further, plaintiffs have not identified any evidence that Raines intentionally misled investors through his statements concerning the implementation and operation of these accounting policies."

Leon has yet to rule on the other class actions involving other Fannie Mae executives.  I look forward to reading them when published, and I hope for the best for all of them.  But the dismissal of the class action against Raines hopefully offers strong caution against leaping to conclusions or attributing evil intent when people or organizations make mistakes or misapply complicated rules.  Raines released a statement after the ruling in which he noted that

“Today’s decision puts to rest unwarranted allegations that I have spent eight years refuting.  These reckless charges have wreaked untold damage on me, my family, my career ,and  my reputation.  But I cannot help but echo the question asked by former Labor Secretary Ray Donovan when he asked ‘which office do I go to to get my reputation back.’”

As Leon concludes,

"A failure to understand, or even negligent behavior, is not the equivalent of the necessary intent to deceive or conscious disregard of obvious risks."

In this season of increasing hyperbole and name-calling, it's judicial advice worth keeping in mind.

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Freaky Friday

August 22, 2012

It must have seemed like “Freaky Friday” to the Treasury Department last week after it announced that the government is replacing the 10 percent quarterly compounding dividend it’s been charging Fannie Mae and Freddie Mac with a sweep of all of Fannie Mae’s and Freddie Mac’s profits. Republican congressional leaders attacked the move, the conservative commentator Peter Wallison lauded it, and Democratic congressional leaders ignored it.

It’s not every day that the US Government effectively takes over private companies.  The Administration actually has worked very hard to avoid it in the case of auto companies and other failed financial services companies that got bailed out.  But Fannie and Freddie are now working 24/7 for the American taxpayer.  And the change greatly reduces the likelihood that they will need further capital infusions to cover their guarantees, further protecting taxpayers.  

Think of this as the part in the gangland movie when the loan shark informs the hapless borrower that they’ve run out of time to repay and the Mob is now taking over their business. 

You’d think that those who have been the fiercest critics of the GSEs and the rescue of their MBS investors through Treasury capital infusions would be ecstatic.  No more capital infusions.  All profits flowing to the taxpayer.  No qualification that the sweeps will end when the total principal already invested is paid off.  Plus a clear statement that the Administration is committed to winding down the companies and an acceleration of the mandated run-off of their portfolios.

But that’s not how it worked out on Freaky Friday.

Instead, Republican congressional leaders attacked the decision.

“The reduction of the dividend payments for Fannie Mae and Freddie Mac will ensure the American taxpayers remain on the hook for the bailout of these two failed institutions for the foreseeable future,” said Rep. Scott Garrett (R-NJ) in a press release. The chairman of the Capital Markets Subcommittee of the House Financial Services Committee continued, “The crony-capitalism that has become a centerpiece of the Administration’s failed economic policy must come to an end.”    His colleague Rep. Spencer Bachus (R-AL), Chairman of the full House committee, added in his own release that “Eliminating the dividend that is owed to taxpayers irresponsibly benefits speculators and pre-conservatorship GSE stockholders at the expense of the American public.” 

 “Crony capitalism?”  The only cronies this move benefits are taxpayers, for whom the two companies are now working full time.  “…benefits speculators and preconservatorship GSE stockholders…?”  The Administration’s move actually finishes off any hopes speculators might still have had.  Common shares of the companies remain around $0.25, about where they were before the announcement and down from around $80 per share in 2004.  Their perpetual preferred stock, privately held mostly by speculators hoping the companies would eventually be rebooted as private entities, fell 55 percent on the announcement.  The companies are dead meat for investors until a “final solution” is crafted.  Even then, the Administration has made it clear that Fannie and Freddie as they existed before the financial meltdown are dead and gone.

Garrett’s and Bachus’ central complaint, that the Administration has not offered a comprehensive exit strategy and new mortgage finance system design, can’t be denied.  The Administration said as much themselves calling the change an interim step on the road to a full decommissioning of the companies.  Although these members are in the House majority, Republicans there also have failed to produce any legislation at the full Committee level to move past the current situation. 

Meanwhile, over at the American Enterprise Institute (AEI), the deep well of conservative thought and anti-GSE advocacy from which House Republicans usually drink heartily, senior scholar Peter Wallison was singing a different tune.  In an interview with BloombergBusinessWeek.com, Wallison said,

“The most significant issue here is whether Fannie and Freddie will come back to life because their profits will enable them to re-capitalize themselves and then it will look as though it is feasible for them to return as private companies backed by the government. What the Treasury Department seems to be doing here, and I think it’s a really good idea, is to deprive them of all their capital so that doesn’t happen.”

Meanwhile, House and Senate Democrats, and Senate Republican leaders on the Banking Committee have been shrouded in radio silence.  I searched their websites and Google News for quotes or reactions and found none.  Even the normally irrepressible Sen. Chuck Schumer (D-NY) took a pass on the issue. 

Freaky Friday, indeed.

Market Response

The biggest driver of the Treasury’s changed policy was the looming cap on new capital infusions that takes effect at the end of this year.  Market fears that this cap might erode the effective government guarantee behind GSE mortgage backed securities had widened spreads between GSE bonds and Ginnie Mae bonds.  The latter carry an unambiguous full faith and credit guarantee.  The Treasury strategy seems to have worked, at least initially.  BloombergBusinessWeek.com reported on August 17 that spreads had narrowed, albeit by only a small amount, in the immediate wake of the announcement.  An analyst quoted in the article speculated that some buyers who have been wary of the GSE bonds because of the potential cap on Treasury support would be more likely to return after the announcement.

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Fannie and Freddie’s Big Loan Mod

August 17, 2012

The Administration today gave Fannie Mae and Freddie Mac a major loan modification and moved a step closer to their de facto nationalization by eliminating the quarterly compounding dividend payment they have been paying and replacing it with a sweep of any operating profits generated by the companies after paying for operations and reserves.   While these moves fall far short of the comprehensive plan for the mortgage system’s future promised in the Administration’s 2011 White Paper, they reinforce an emergent bipartisan Congressional and stakeholder consensus on the need for a continuing future federal role in assuring a stable and consumer-friendly mortgage finance system. 

In 2008, Treasury rescued Fannie and Freddie from insolvency and provided fresh capital to the companies by purchasing senior preferred stock, initially $100 billion each.  Existing common stockholders and other preferred stockholders were essentially wiped out, and the infusions enabled the companies to continue to intermediate capital investments in housing.  Good thing, too – as private investors fled the mortgage market, Fannie and Freddie’s share of mortgage financings grew to record-high levels, along with FHA and its securities gurantor Ginnie Mae.  Together these entities now provide nearly all capital used for refinances and home purchases.

As time went on and the companies’ distress from failed loans in securities they had guaranteed deepened, Treasury increased its infusions, ultimately committing to unlimited support through 2012, when the commitment would be capped at outstanding commitments made in 2010-2012, plus a maximum additional amount of $200 billion each.

The government’s help didn’t come cheap – both companies were required to pay quarterly compounding dividends of 10 percent on the capital advances, or twice as much as bank recipients of TARP funding paid.  Since Treasury’s investments began, the companies have paid out $45.7 billion in dividends on a total of $188 billion in Treasury capital infusions.  And because these payments were required every quarter, both companies repeatedly have had to seek additional Treasury assistance, primarily to pay the dividends, turning the Treasury agreements into perhaps the biggest, baddest payday loan ever.

Working with the companies and their conservator, the Federal Housing Finance Agency, Treasury has now amended these agreements.  The required quarterly dividends have been converted to a claim on all profits generated by the companies after paying for operations and maintaining a capital reserve fund.  Rather than continuing to accrue a compounding repayment obligation, the agreement caps the repayments to this amount.  Whether the commitment would end should the companies manage to pay back in full the amounts already advanced by Treasury is unclear; the amended agreements run through 2017.  But Treasury’s announcement states that the GSEs “…will be wound down and will not be allowed to retain profits, rebuild capital, and return to the market in their prior form,” and given the large amounts already advanced such a full repayment seems unlikely for the foreseeable future.”

Reassuring the Market

This shift from dividend to profit sweep converts Fannie and Freddie’s repayments from an above the line expense to a below the line expense.  This means that while the companies still have to repay the Treasury and taxpayers for their support, they will do so out only if their operating income exceeds their costs.  Under the agreements released today, no dividend obligation will be collected or, more importantly, accrue in any quarter where the companies do not meet this test.  Given that both Fannie and Freddie reported sufficient net income in the last quarter to fully repay the dividend and fund all their operations without needing additional Treasury support, the conversion greatly reduces the likelihood that any further infusions will be necessary.  

The change also should ease investors’ concerns over the capping of Treasury commitments that takes effect at the end of this year.  While the dividend payments were an above the line expense, they posed a constant drag on earnings and a threat that more Treasury capital would be needed to pay for them.  With contributions capped, investors feared that the day might come when the government’s backing for the companies effectively ended, throwing the value of their securities guarantee into doubt.  This anxiety is part of why investors have bid up the price of Ginnie Mae securities and bid down GSE bonds recently.  Today’s announcement likely will eliminate that concern.  Higher bids for GSE bonds would be direct evidence of that.  This should also mean lower mortgage costs for borrowers using conventional, rather than FHA, loans, since the bonds’ yields should rise.

Treasury also announced some other changes in GSE oversight today.

  • Fannie and Freddie will be required to submit an annual report to Treasury “…on its actions to reduce taxpayer exposure to mortgage credit risk for both its guarantee book of business and retained investment portfolio.”
  • The companies will accelerate the wind down of their mortgage portfolios from the current 10 percent per year to 15 percent per year, and reach a stabilized level of $250 billion each four years earlier than under the previous plan.

Who’s Your Daddy?

These changes mark a subtle but important shift in the government’s relationship with the GSEs.  The original investment model made Treasury and the taxpayers “super investors” in the companies.  They provided capital for entities still operating in theory as independent but heavily supervised private companies.  This left open the possibility, however remote, that the companies might someday be able to claw their way out of their hole, buy back the senior preferred stock and emerge intact from conservatorship. 

Now Treasury has made it clear that they basically own the companies and will collect every dollar of retained or excess earnings they produce.  When combined with FHFA’s own Strategic Plan for the companies’ future, the change moves the government closer to a path through which Fannie and Freddie are reengineered into a government owned operation of some kind to carry out the important utility functions needed to support a liquid mortgage securities market.

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Foreclosed homes - What to Do?

April 06, 2012

With millions of families displaced by foreclosure, and their homes often sitting vacant and vandalized while the torturous process of foreclosure grinds on, new ideas have emerged about how to make better use of this inventory, especially to provide afforable rental housing while preserving the homes and preventing further deterioration of neighborhood values and conditions.  Literally billions of dollars in new investor equity has been marshalled in anticipation of bulk property sales that could provide bargain-priced homes that could be repurposed to rentals and eventual sale when markets improve.  Locally, “mom and pop” investors are bidding for these homes, and new would-be property owners/investors are showing up on courthouse stairs to bid for these properties.

At the federal level, the Federal Housing Finance Agency (FHFA) is pushing Fannie Mae and Freddie Mac to experiment selling some of their REO in bulk to investors who would convert the properties to rentals.  

Bank of America recently announced its own “Lease for Deed” pilot to allow curernt delinquent homeowners to swap their ownership for a long-term lease.  The program could lead to these families having the opportunity in the future to buy back the homes, as well.  If the pilot shows promise, BofA says they will expand it.

I was recently a guest on KCRW’s To the Point broadcast, which you can listen to here.

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