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Refis for Underwater Borrowers
February 10, 2012
WSAV4 TV in Savannah, GA interviewed me there while I was attending a Mercy Housing, Inc. board meeting on February 1, 2012, the day that President Obama announced the Administration's proposal to have FHA help underwater borrowers refinance their loans.
A New Consensus?
September 11, 2011
As Washington has sweltered under a record heat wave this spring and
summer, another thaw of sorts has been taking place on Capitol Hill.
After two years of intensely partisan and polarizing positioning around
the future of Fannie Mae and Freddie Mac, two bi-partisan proposals have
created a new front that could signal a more hopeful future for the
The two bills are HR 2143 sponsored by California Republican Gary Miller and New York Democrat Carolyn McCarthy and HR 1859 sponsored by California Republican John Campbell and Michigan Democrat Gary Peters are very different in key respects.
While the bills take radically different paths to a new market
paradigm, both start from the premise that the federal government should
continue to play a key role in the nation's mortgage system. Both
bills would authorize government support for mortgage securities. Both
would create new entities to succeed the failed mortgage giants Fannie
Mae and Freddie Mac. And both would charge a new fee to cover the cost
of an explicit and limited guarantee of mortgage securities - not
entities that issue them. These common elements establish a new anchor
for the debates to come in the House and Senate over the future of the
mortgage finance system.
Until now, the only comprehensive Republican-backed proposal for a post-GSE world has been Rep. Jeb Hensarling's HR 1182,
which would wind down Fannie and Freddie and leave no enduring federal
role in the conventional mortgage market. Other Republican members of
the House Financial Services Committee have introduced a flurry of bills
that each attacks a different aspect of the GSEs' conservatorship and
collectively endorse a much more constrained federal role. Rep. Scott
Garrett's Capital Markets subcommittee has held hearings and mark-ups of
these bills, but the full Committee has yet to schedule time to
consider them. Hensarling's bill, and the adamant opposition to any
continuing federal support for mortgage finance that it symbolizes, has
support from Republican freshman back benchers, and surely will claim
vocal support once the full Committee begins considering options.
The Miller-McCarthy bill would establish a publicly owned and
operated "credit facility" for securitizing loans for both ownership and
rental housing. The entity would absorb the current operations of
Fannie Mae and Freddie Mac; those companies would be wound down through
the current conservatorship. The new facility would maintain a
portfolio, principally for enabling the facility to be a countercyclical
force in the market, to modify delinquent and defaulted loans it has
guaranteed, and to carry out specialized multifamily rental housing
finance. The new facility would be governed by an independent board,
and regulated by the current GSE regulator, the Federal Housing Finance
Agency (FHFA). Although owned and operated by the US government, the
facility's workers would neither be government employees, nor subject to
its normal workplace and compensation rules. The facility would charge
two separate fees for its securities - one to provide a top level
guarantee, much like Fannie and Freddie historically have done, and a
second to finance a new insurance fund to provide a catastrophic back-up
guarantee. As with Fannie and Freddie, loans with less than 20 percent
borrower equity would have to have further credit support, either
through private mortgage insurance or participation by the originating
The Campbell-Peters bill would authorize the establishment of new,
chartered mortgage guarantors backed by private capital to guarantee
securities for both rental and ownership. These entities could be owned
by any financial services entity, including through lender
cooperatives. While the new entities could operate portfolios, they
would do so without any federal support. Their securities, meanwhile,
would enjoy a catastrophic guarantee that would be financed through a
fee paid by consumers. While this guarantee would protect investors in
the mortgage backed securities issued by the new entities in the event
their own capital is exhausted by losses, it would extend no protection
to the investors or bondholders of the new entities. The entities would
be chartered and regulated by the FHFA, and like Miller-McCarthy, would
require additional credit support for loans with less than 20 percent
The sponsors' common embrace of a federal role in supporting the
housing finance market is important because much of the debate around
mortgage finance reform has hinged exactly on this point.
Free-marketeers and conservatives generally have argued against any
continuing federal role in the markets outside of FHA. According to
these advocates, government involvement in the housing market was a
leading cause of the mortgage crisis. In this narrative, increasing
levels of directly and implicitly subsidized federal involvement in the
housing markets since the Great Depression led to the catastrophic run
up in housing prices in the 2000's, the rise of subprime lending,
inflated house prices and the credit bust of 2007-08. They argue that
only when the private market is allowed to operate without government
involvement will markets stabilize.
The other side of this polarized debate has argued that market and
regulatory failures in the early 2000's led to an explosion of private
label mortgage securities fueled by an unregulated "originate to sell"
underwriting model that fueled a race to the bottom in standards as
originators, lenders, securitizers and investors sought ever greater
volumes of supposedly safe and high-yielding mortgage securities. In
this model, Fannie's and Freddie's market dominance - and the
underwriting standards that had long dominated the market - were outrun
by the private securities market. Their singular focus on residential
mortgages and their very thin capital requirements put them in extreme
jeopardy when the market collapsed, and their peculiar private ownership
model led them to try to follow the stampeding herd into riskier loans
in order to regain market share lost to private label securities,
leading to catastrophic losses and government takeover. This narrative
concludes that while the private ownership/implicit federal guarantee
model of the GSEs is not sustainable any longer, a more constrained and
focused federal role remains critical to ensuring liquidity, stability,
and access to affordable and sustainable mortgage credit.
It looked like the debate over housing finance reform would turn into
a straight-up death match between these views. But the introduction of
these two bills has changed that dynamic. Neither bill is ready for
prime time; they are both more like conceptual sketches than working
blueprints. Progressives will find fault with both of these proposals -
neither makes a significant effort to assure these new entities serve
all communities and households, avoid "creaming" the markets, or extend
credit to otherwise underserved areas. Conservatives will oppose the
bills' fundamental embrace of a federal role. But that agreement in the
bills to a fundamental support for a government role and the use of an
explicit federal guarantee that is priced and paid for means that the
debate's center of gravity has shifted significantly away from the
bipolar extremes of only a few months ago.
There is little prospect of either of these bills moving forward any
time in the near future. And it's likely that a significant portion of
senior committee leaders and restive back benchers will continue to push
for the elimination of federal support in mortgage markets.
But Miller, McCarthy, Campbell and Peters have vowed to press for
hearings on their bills, and to bring them up whenever GSE reform is
discussed in the House Financial Services Committee. The fact that
Republicans and Democrats are beginning to talk about the same
fundamental premises and are collaborating together to design a new
approach based on them is notable in its own right as a bright spot in
an otherwise polarized landscape. It gives the Administration more room
to maneuver as it readies Version 2.0 of its own proposals. It will
shift the debate's middle ground further to the left than seemed likely
only a few months ago.
August 19, 2011
The government last week launched a new “Request for Information (RFI)”
asking for suggestions about how to take Fannie Mae’s, Freddie Mac’s
and FHA’s inventory of foreclosed homes and move it in bulk into the
hands of private investors so they can convert them to rental units.
The solicitation states that it is seeking
“ideas for sales, joint ventures, or
other strategies to augment and enhance Real Estate-Owned (REO) asset
disposition programs of Fannie Mae and Freddie Mac (the Enterprises) and
the Federal Housing Administration (FHA).... A specific goal is to
solicit ideas from market participants that would maximize the economic
value that may arise from pooling the single-family REO properties in
specified geographic areas.”
I’m glad the Administration has reawakened its interest in the
housing markets after two years of the weak showing of its flagship
“Making Home Affordable” mortgage modification program. Maybe the
solicitation will generate proposals to optimize the GSEs’ management of
their REO and use existing public investments in the firms to achieve
long-term public benefits. But it’s much more likely to elicit offers
from private equity to buy properties in bulk at a steep discount to
convert to rentals and ultimate resale. If this is the case, it seems to
me the Administration would be deliberately throwing away an
opportunity to turn the GSE lemons into at least a weak lemonade and
missing the chance to use its stranglehold on Fannie Mae and Freddie Mac
to do something useful.
What It Says
The RFI lists the following key objectives:
• reduce the REO portfolios of the Enterprises and FHA in a cost-effective manner;
• reduce average loan loss severities to the Enterprises and FHA relative to individual distressed property sales;
• address property repair and rehabilitation needs;
• respond to economic and real estate conditions in specific geographies;
• assist in neighborhood and home price stabilization efforts; and
suggest analytic approaches to determine the appropriate disposition
strategy for individual properties, whether sale, rental, or, in certain
instances, demolition. FHFA, Treasury and HUD anticipate respondents
may best address these objectives through REO to rental structures, but
respondents are encouraged to propose strategies they believe best
accomplish the RFI’s objectives. Proposed strategies, transactions, and
venture structures may also include:
• programs for previous homeowners to rent properties or for current renters to become owners (“lease-to-own”);
strategies through which REO assets could be used to support markets
with a strong demand for rental units and a substantial volume of REO;
• a mechanism for private owners of REO inventory to eventually participate in the transactions; and
• support for affordable housing.
Equity funds that have been busily raising capital in anticipation of
swooping in on distressed assets have an obvious reason to want the
government to give them Fannie’s and Freddie’s homes on the best terms.
They’re hoping for a windfall when markets come back and these homes
could be sold once more for a profit. Renting them in the meantime
while values and demand remain depressed would be a good strategy in
many markets, although the challenges of adequately managing scattered,
single family rental units is no small thing. It would reduce vacancies
and expand the supply of rentals at a time when they’re badly needed.
And real estate interests, state and local governments and communities
themselves are terrified by the looming flood of foreclosed homes that
is building up and depressing home sales and prices. They likely would
welcome any moves that would slow down the torrent.
But why should the government be so anxious to engineer the transfer
of thousands of properties into private hands, when it could hold them
itself through the GSEs, offer them for long-term rentals, protect
communities from opportunists and profiteers, and keep that potential
upside for itself?
America’s Best Landlords?
The problem with turning to the private sector to move these
properties out of the GSEs’ hands is that these interests ultimately
will want to generate sufficient profits to give their investors
competitive returns. This will mean one or a combination of outcomes:
• Once acquired, maintenance and
upkeep on the properties will be held to a bare minimum to maximize the
rate of return on rental income. See “Slumlords, neighborhood
deterioration” for further details.
• Homes will be flipped as soon
as possible to new investors who couldn’t bid for large numbers of
units. See above or below, repeat.
• Investors offer smaller lots of
homes to state or local governments, at a mark-up that secures their
return, hiking the ultimate cost of the homes.
• Homes are maintained
and held until the market firms up, rents are set at the highest level
possible, then the homes flipped to new owner-occupants, who will have
to pay a high enough premium to generate equity-like returns for the
A recent news story
on mortgage fraud noted that “Fannie Mae continues to investigate REO
flipping involving real estate agents who withhold competitive offers on
REO properties so that they can control the acquisition and subsequent
flip.” In other words, private sector real estate interests already
have found ways to scam the REO disposition process to enrich
themselves. Freddie Mac published an article on its Executives Perspectives Blog outlining its increased attention to fraud by real estate professionals in arranging short sales.
Fannie and Freddie are effectively owned by the US government. They
no longer have to worry about shareholders’ interests, or Wall Street’s
assessment of the net profit potential of their programs. In another
time, progressives might have lobbied for the government to set up a
dedicated entity to facilitate the clearance of excess real estate
inventory and do the utmost possible to protect current homeowners and
local markets. But the government already has this solution to hand in
Fannie Mae and Freddie Mac. So why not use them for this purpose?
This would keep the properties occupied and generate some revenue.
This could be used to offset what they paid to redeem the mortgages from
investors, and cover ongoing maintenance and management costs. As
markets stabilize, properties could be put into the for-sale market at a
controlled pace with an absolute preference for new owner-occupant
buyers, in many cases even the families then renting the homes. Unlike
private investors motivated by the need to generate the highest possible
short-term return on investment, this approach would allow for more
patient management of the rental assets and a focus on the social and
community returns, as well as the financial ones.
It’s the Politics, Stupid
Nothing illustrates the quandary of Fannie and Freddie’s
conservatorship more starkly than this paradox. Politics in Washington
means that the GSEs can’t be allowed to enter into any projects that
could extend their lifetimes any longer than minimally necessary. So
there is a premium on solutions to the REO dilemma that move the assets
off their books as quickly as possible. Even if that means
relinquishing the positive role that government could play by leveraging
its patient capital to directly manage these assets in more creative
and responsible ways.
Some respondents to the RFI may propose making better use of the GSEs
themselves through direct management of the assets, or through some
joint venture that would keep the assets at least nominally under public
oversight. But I suspect that most of them will focus on how to move
the assets into private hands with the lowest cost and fewest strings.
Realistically, no matter what Congress decides to do with Fannie and
Freddie over the next few years, there are going to be long-term legacy
resolution issues like the REO problem that will have to be managed.
The government could reimagine conservatorship as a means to broker
long-term stability in distressed markets by using taxpayers’
investments in the GSEs as patient capital deployed for public purposes
rather than merely as a “bail out” to be unwound as quickly as
possible. Nothing would stop Congress from developing a new, long-term
mortgage finance structure and barring Fannie and Freddie from doing any
new business after a date certain. But that need not preclude the
continuing management of the legacy book, and particularly the troubled
book and REO, by the companies through an extended conservatorship or
through some other reorganization focused on the orderly unwinding of
their assets and obligations.
It seems to me that the constraint is not economic or managerial.
It’s political. In the current climate, that may be all it takes to see
the government give up one more opportunity to do the obvious in favor
of the short-term and potentially much more costly option of
MN Public Radio on foreclosures
July 12, 2011
UMinn law professor and former MN Assistant Attorney General and I discuss foreclosures in this call-in radio program.
June 22, 2011
When Congress adopted the Dodd-Frank legislation last year, it
included a provision to require entities that create asset backed
securities of any kind to hold at least a 5 percent interest in the
securities. This so-called “skin in the game” provision was intended to
better align the interests of borrowers, loan originators, and
investors by assuring that the entities putting together securities
backed by mortgages and other assets have a long-term interest in the
success of the underlying loans.
The task of actually defining the so-called “Qualified Residential
Mortgage” (QRM) exemption was assigned to a gaggle of 6 federal
regulators. Their proposed rule was published back in April, with an initial 60 day comment period later extended until August 1, 2011.
The QRM exemption is important for a couple of reasons.
- Mortgages that don’t meet the QRM requirements will cost more
because of the risk retention requirement. How great a price
differential this will involve is the subject of continuing research and
disagreement. The FDIC has said, for instance, that they believe the
difference will be only one-tenth of a percent, not a significant price
increase. Moody’s.com economist Mark Zandi, however, just published his
of the proposed rule and estimates that the increased cost could be
between three-quarters of a percent to a full percentage point.
- Once the federal regulators—who include all the prudential banking
regulators—adopt a standard that denotes the “safest” mortgages, it’s
possible that investors and even portfolio lenders will shy away from
securities backed by mortgages with lower down payments, further raising
the cost and restricting access.
- As Congress considers further mortgage finance system reforms, the
QRM standard could become an attractive “tent pole” around which to
organize lending standards of an overhauled FHA and whatever successor
structure is erected for Fannie Mae and Freddie Mac.
What it Does
In order to qualify for the QRM exemption, a security would have to
be composed entirely of mortgages that meet the following criteria:
- At least 20 percent down payment for purchases, 25 percent for rate and term refis, and 30 percent for a cash-out refi
- No 60 day late payments on any credit obligations for the 2 years
preceding origination, and no 30 day lates at the time of origination
- A mortgage debt-to-income ratio of no more than 28 percent, and a total DTI of no more than 36 percent.
In addition, QRM mortgages cannot include features like teaser rates,
balloon payments, interest only payment plans, or so-called Option ARM
payment plans, features which played a prominent role in the housing
finance bubble and crash.
The proposed regulation has generated a firestorm of protest from all
points of the housing policy compass. Consumer groups, lenders, real
estate interests and others involved in the home buying process have all
scored the proposal’s requirement for a 20 percent or greater down
payment as unnecessarily shifting a large portion of all renters into
the non-QRM mortgage space.
With a median home price nationally of around $170,000, a 20 percent
down payment would require a renter to come up with $34,000 plus closing
costs. This is a hurdle few renters without rich parents or other
sources of gifts will be able to make. The Harvard Joint Center for
Housing Studies, for instance, has estimated that the median renter
household has about $1,000 in cash savings, and the median minority
renter household only about $500. Even at the 75th percentile, these
numbers are $5,000 and $2,500, respectively.
These points are laid out in a White Paper
published by a broad coalition of groups and released on June 22, 2011.
The following Market Place Radio report gives a very brief explanation
of the issues:
The statute exempted loans insured by FHA from the risk retention
provisions because of their full faith and credit backing. The
proposed rule would also not apply to Fannie Mae and Freddie Mac, as
long as they remain in conservatorship, because of the Treasury’s
explicit backing of their obligations. With these 3 entities
responsible for 90 percent of current mortgage finance, the QRM rule is
unlikely to have an immediate impact even after the current review and
comment period, and the mandatory one-year gap between final rule
adoption and implementation.
But as the Administration moves forward on recommendations in its February, 2011 White Paper on mortgage finance reform
and tries to shrink the size of the market in which both FHA and Fannie
and Freddie can operate, the QRM rules will apply to more and more
mortgages. And there will be great uncertainty about their impact for
years to come until Congress resolves what to do about Fannie and
Freddie and the mortgage finance system generally.
Will QRM Mitigate Risk?
Whether or not the proposed risk-retention rules will genuinely
increase the quality and performance of mortgage backed securities is an
underlying question. Even at the height of the most irresponsible
underwriting and loan origination, many securitizers did hold some
underlying risk on the securities they created becuase they thought the
risks were small and the gains would be great. They were proved wrong
when house prices started falling rather than rising, and poorly
underwritten loans started failing in large numbers. But their
retention of risk was hardly an impediment to bad financial decisions
and lack of attention to the underlying quality of the loans being
packed for sale to investors.
The rule also has some other, more technical aspects that lenders are
very concerned about; Zandi’s paper elaborates on these, as well. And
the rule would prohibit any second mortgages before or at the time of
origination. This provision will effectively halt the popular and
successful state and local programs that use so-called “soft seconds” to
help low wealth borrowers into their first home. This would deal yet
another blow to affordable homeownership efforts for low income and low
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