Fannie, Freddie & FHA: "Guaranteed" to inflate mortgages or help?
When it comes to Fannie, Freddie and FHA, the decade old debate continues: what should the role of government in housing finance be? Should government still guarantee the principal and interest on your mortgage. Supporters say the guarantees make mortgages affordable. Opponents say it inflates prices and puts taxpayers at risk. But both agree that the model, essentially entities with a public purpose and risk, but private profit, is flawed.
I might add though that, notwithstanding all the criticism, these entities achieved their initial purpose with flying colors. FHA was established after the Depression. At the time the only home loans were short term (3 to 5 years) and low LTV (50 to 60%). When banks crashed so did mortgages, unemployment and foreclosures surged and home prices plummeted. The banking system was restructured and FHA created to encourage lenders to make mortgage loans by provide insurance that borrowers would repay them. Homeownership increased to 40%. After WWII, and again in the 1950s, 60s,70s, 80s FHA has helped keep home loans available and thus home prices stable during financial crises, especially for minorities and younger buyers. Fannie Mae was founded in 1938, also to encourage banks to make home loans, but this time by actually buying the loans, pooling them and then reselling them as securities.
Over the years since, a lot changed in the way Fannie is owned and run including the creation of Freddie Mac to increase mortgage loan options and efficiencies. And the world has changed, hence the debate over what to do with Fannie, Freddie and FHA, which at this point dates way back. Even before the bailout there were scandals. But the bailout, which cost taxpayers almost $190 billion seemed like the final straw for Fannie and Freddie and we recently learned FHA not in good financial shape.
First came the FHFA conservatorship of Fannie and Freddie mandated by Congress in 2008. FHFA has reported it is essentially taking a 3 step strategy: to create a securitization platform and protocols designed to enhance transparency, uniformity and other adjectives that make private investors feel more comfortable, reduce Fannie’s and Freddie’s role in housing finance (for example by eliminating non-essential business, reducing portfolios and such) and get the private sector in. The challenge of course is to still maintain affordable mortgage availability.
EARNINGS RISK: In the most recent, now fifth FHFA report to Congress last month we learned that the GSE’s earnings have been upgraded from “critical concern” to “significant concern.” 2012Fannie earned $17 billion, the third most profitable financial institution after JP Morgan Chase and Wells Fargo. Freddie earned $11 billion.
CREDIT RISK: But their credit risk remains the same due in part to 2005 to 2008 mortgages. Loss mitigation remains an issue with 1.7 million REOs on GSE books according to RealtyTrac. Much was said about Fannie’s REO to Rental pilot program a year or so back. Perhaps you recall, Fannie sold 1700 homes in 3 bulk sales and then nothing further was heard. The problem is Fannie gets back about 65% of unpaid principal balance on these units. That’s up from 56% in 2012 thanks to better systems and a better housing market in general, but still not stellar. And about 42% of Fannie’s are tied up in redemption. Others are still occupied, some under the lease for deed program. Others need repairs and can’t be sold yet for that reason. All told, the GSEs take about 200 days after foreclosure to sell their homes. Per a recent GAO report, FHA takes 340 days which is 60% longer. And gets about 5% less money Adding a total further loss of about $600 million. That may be because FHA doesn’t repair units, pricing and price reduction policies differ, many policies have not been updated since 1994, FHA handles contractors differently and does less frequent inspections. Delinquencies in general have been down for 5 months but were up by almost 10% from May to June and are now at almost 7% which may be seasonal and are still down 6.5% year over year. Still, as of June almost 5 million homes were 30 days late or more or in foreclosure (3.32 million in default/1.46 million in foreclosure). Florida tops the list. Another 1.2 million HAMP modifications have been done since 2009 and 300,000 have re-defaulted Re defaulting is now 26%. $815 million in incentive payments lost according to a recent SIGTARP report.
CENTRAL ROLE: Perhaps most significant, last year the GSE’s guaranteed $1.3 trillion, or 77% of all new mortgages. And they control a portfolio of 31 million mortgages worth $5 trillion.
Why No Congressional Decisions?
I recently ran into Senator Dick Durbin and asked him what’s going to happen with Fannie and Freddie. He essentially said nothing for now. While there have been changes like new compensation plans including raise freezes, 10% reductions and CEO compensation set at $600k, the central role has remains the same. Reasons include lack of a political appetite to mess with housing finance – threatening American homeownership in general is not popular. But also, the fact that no one wants to forego what has now become an earnings gravy train, particularly at a time when the Federal government can and has been using the money elsewhere. One new interesting development is that the government is now being sued by investor arguing neither Fannie nor Freddie satisfied any of the 12 financial and other criteria for takeover outlined in Housing and Economic Recovery Act of 2008. Nevertheless, government forced the delisting of GSE shares, terminated shareholder meetings, assumed more subprime assets, accepted money from Treasury and the GSEs had to grant Treasury allegedly “usurious” 10 to 12% cumulative dividends. The U.S. Treasury holds $188 billion senior preferred stock and keep profits beyond capital buffer. Treasury also holds warrant to acquire almost 80% of outstanding common stock. In the big picture, the government has claims on all profits but don’t take any liability on balance sheet. It almost sounds un-American now. We can expect more lawsuits like this now that Fannie and Freddie are profitable. And, incidentally, those profits count as return on investment, not repayment of the debt. Hedge funds are also now lobbying Congress to make the GSEs independent again (there’s no official provision for exiting conservatorship).
- CHANGES HAPPENING WITHOUT CONGRESS: And yet change happens. In this case, GSE and FHA loan products are costing borrowers more. For example, FHA now requires mortgage insurance for life of loan in most cases (it used to be that you could eliminate mortgage insurance once you built equity in the home). Fannie and Freddie are charging higher guarantee or “g” fees. And mortgages are getting tougher to qualify for. 20% of those who qualified during bubble can't now. The biggest impact is on first time buyers, but in the long run shifts like this could impact home values and liquidity for all of us and brings to question the value of American homeownership in general – is it something government should protect? In another interesting turn, former Consumer Financial Protection Bureau Deputy, Raj Date, has established Fenway Summer LLC, a company he says will make a run at $1.5 trillion of $10 trillion mortgage market comprised of folks who won’t be able to qualify for standard “qualify mortgages” under the new rules his own CFPB wrote which take effect in January 2012. Fenway will instead offer interest only and 100% financing loans to these folks – sound familiar? FHA has already changed its reverse mortgage programs by eliminating some programs, increasing fees and decreasing loan amounts. These loans used to be known for no real underwriting or credit score but 10% in default, oftentimes because borrowers can pay their real estate taxes and insurance. New proposals require financial assessment and credit score and set aside at least 2 years escrow for taxes and insurance. This has passed the House, is pending in the Senate and would take effect in October. It will have a bigger impact now due to pension and retirement savings losses.
- WHAT IS CONGRESS DOING? So there are proposals suggesting more specifically what to do with Fannie Freddie and FHA but most inside the beltway agree they are more for purposes of getting the dialogue going. The House Financial Services Committee proposal lead by Jeb Hensarling (R-Tx) favors a fully private system. They’ve approved a Bill to unwind the GSEs and replace them with system without government guarantees, creating a utility to develop best practices for new private mortgage market. This is not likely to get full Congressional support.
Competing legislation in the Senate from Mark Warner (D-VA) and Bob Corker (R-TN) has more bipartisan support. It would dissolves the GSEs over 5 years, creates a new federal agency of private mortgage insurers pursuant to which private participants hold 10% of first losses and government reinsurance kicks in after that. It transfers FHFA authority to a “Federal Mortgage Insurance Corp” modeled after the FDIC and would charge explicit fees to cover operating cost and a catastrophic fund placed in a “Mortgage Insurance Fund.” The FMIC would set standards for eligible loans and a standard securitization platform. Other proposals eliminate the GSE affordable housing goals replacing them with counseling and rental assistance goals. Another concern is that smaller banks and credit unions won’t be able to compete.
Senate (Banking Committee) FHA Solvency Act of 2013. Seek indemnity from lenders. Change HECM. Mandatory premium increases if reserves drop certain level.