Not long ago we heard—again—that the Federal Housing Authority (FHA) may need almost a billion dollar tax payer bailout to stay afloat.
FHA was established after the Depression, at a time when the only home loans available required a 40 or 50% downpayment, and had to be repaid in three or four years. Today’s national and international financial institutions did not exist yet, so very few Americans were able to buy and own their own homes. And when banks crashed with the Great Depression, so did what there was of a mortgage market. Sound familiar? Unemployment and foreclosures surged and home prices plummeted. Sound even more familiar? As a result the U.S. banking system was restructured, and FHA was created, in order to encourage lenders to make home mortgage loans by providing insurance that home borrowers would actually repay them.
One important outcome was that American Homeownership increased to 40%. That was the goal. So when folks criticize FHA, and this is not to say that change is not called for, my “go to” response is that in the big picture FHA succeeded at its mission. After WWII, and again in the 1950s, 60s, 70s, and 80s, FHA has helped keep home loans available to average Americans, especially for minorities and younger buyers, and thus kept home prices stable during recurrent financial crises. FHA generates income, among other ways, vis-à-vis mortgage insurance premiums (MIP) which borrowers pay at the time of closing, and on a monthly basis with each mortgage payment. FHA also backs the reverse mortgages many older Americans count on today.
The Federal National Mortgage Association (FNMA or Fannie Mae) was founded during the Depression era in 1938, also to encourage banks to make more home loans, much like the FHA. However, this time the loans were actually bought, pooled, and then resold as mortgage-backed securities, or MBS (in a process called securitization) to investors on what is commonly referred to as the secondary mortgage market. This allowed banks to get the loans and risk off their books, and free up their money, to make more home loans to more average Americans over and over. Throughout the years since, a lot changed in the way Fannie Mae is owned and run, including the creation of the Federal Home Loan Mortgage Corp., aka Freddie Mac, to increase mortgage loan options and efficiencies. (Fannie and Freddie together are sometimes called the government-sponsored enterprises, or GSEs). Another important change is that American homeownership increased to around 65%, which again was the goal. And so, again, when folks criticize Fannie or Freddie, it’s important to remember that in the big picture they’ve succeeded.
One other important fact is that although both Fannie and Freddie make money vis-à-vis guarantee fees (g- fees) charged to investors, in exchange for the GSEs guaranteeing loans and other similar models, they are entirely separate entities and are even competitors. Continually lumping them together as we tend to do in the media, politics and minds of Americans is, in some ways, a disservice.
When the real estate bubble popped, FHA, Fannie and Freddie, found themselves knee deep in a lot of bad loans (though even before that there were accounting and other issues). While there were many reasons for this, a leading reason was that as they lost market share to subprime lenders and others during the bubble. The outcome: Fannie and Freddie lost the ability to control the quality of loans to the extent they had been able to before. As a result, they were infamously placed into conservatorship under the Federal Housing Finance Authority (FHFA), and were bailed out with tax payer dollars in 2008 to the tune of over $187 billion.
Now, a variety of ideas are floating around about how to reform them. The number of Americans that rely on FHA, Fannie and Freddie is significant—about 90% of all homeowners with a mortgage today. Historically FHA has accounted for 10 to 15% of mortgages. However, as of this past year, FHA now accounts for over 25% and over 40% of first-time buyers. Already we’re seeing the FHA mortgage insurance increase, forcing homeowners to pay for a longer period of time that before. Effective April 1, FHA’s annual MIP for all loans less than or equal to $625,500 and with an LTV over 95% is now 1.35% of the loan amount. Loans over $625,500 and with LTVs over 95% will now pay 1.55% of the loan amount for MIP. Back in April 2012, the upfront mortgage premium increased to 1.75%. In addition, effective June 3, 2013, loans over 90% LTV will requirement MIP until the earlier of the life of the loan, or 30 years. And proposals to raise the minimum downpayment on loans over $625,500 from 3.5 to 5% are floating around, too. GSE g-fees are increasing, and homeowners in regions where Fannie and Freddie experienced higher mortgage losses may very well wind up paying the costs for higher g-fees moving forward, essentially increasing the cost of buying and owning a home in those regions. We’re also seeing loan requirements tightening, meaning some folks won’t be able to get a loan anymore, and FHA just reduced the types of reverse mortgage loans it will offer older folks, meaning less choice and again likely higher costs. Lest we forget, the additional money buys needed to pay for an FHA or GSE loan may well translate to that much less money buyers are able to pay you or I if and when we decide to sell our homes, eventually impacting everybody’s home values and ability to sell. Longer term it can even impact homeownership levels, which has many further economic ripple effects.
We can expect higher costs and tougher times obtaining a home loan to continue. But additionally we may see bigger longer term changes, particularly at Fannie and Freddie, primarily driven by two forces: the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010, and the Federal Housing Finance Agency. The Dodd-Frank Act required the U.S. Treasury Department to present a plan for reforming Fannie Mae and Freddie Mac by the end of January 2011. On February 11, 2011, the Obama Administration released its proposal for restructuring the housing finance system: Reforming America's Housing Finance Market, A Report to Congress. Among other things, the proposal favored higher downpayments, lower loan limits, and higher g-fees and FHA premiums. Congress has held several hearings on housing finance reform, and several bills have introduced—but so far nothing has been finalized. And folks inside the Beltway agree—more specifically, Sen. Dick Durbin (D-Ill.) told me a few short weeks ago—that, notwithstanding the directives Congress has given FHFA, there’s no real appetite for change now. Talk of reforming the GSEs is nothing new. In fact, proposals on the Hill date back to before the housing crises. For instance, bifurcating the entities’ public and private purpose, making the entities’ guarantee explicit or not at all, and eliminating the special government benefits they receive, so that the private sector can realistically compete, are all well-worn concepts.
What is new is that the instructions that were given by congress to their conservator, FHFA, are now coming to fruition and becoming reality. The “plan” FHFA laid out as a result is now well into the second of its three “phases”, which include combining or reducing the GSE roles, and attempts to get the private sector into the space they now fill. More specifically, the conservator’s stated goals are to build a structure for an entirely new housing finance system, and to contract Fannie and Freddie by reducing their portfolios and loan limits, all while maintaining affordable home mortgage loan availability for average Americans. As we speak, staff in non-core areas of GSE business are being eliminated, Wall Street contractors are building a new securitization platform, and inquiries are quietly being made in and around Washington to find the right candidate to eventually head this newly created entity. Among the key considerations are whether this new platform should address only securities issuances, or extend into credit models, pricing, and customer relationships, too. Getting the private industry to step in, and replace American taxpayer money the federal government is putting at risk in connection with home mortgages, is going to also require making the residential mortgage loan business itself more attractive—which means lower risk and higher profit. Somehow even that sounds like it’s going to cost Americans one way or another.
The Dodd Frank Act also includes further housing-finance-relevant provisions such as the qualified mortgage (QM) and qualified residential mortgage (QRM) rules, which will require careful balancing in order to not upset the proverbial housing market “apple cart.” For example, initial proposals that a 20% downpayment be required in order for a loan to fall under the QM safe harbor led to research indicating that average American families would require 14 years to accumulate that much money. Already the FHFA has directed Fannie and Freddie to limit future loan purchases to those that meet the Consumer Financial Protection Bureau’s (CFPB) “qualified mortgage” loan criteria. Beginning Jan. 10, 2014, the GSEs will go even further, and will no longer purchase loans subject to the CFPB’s “ability to repay” rule, unless they are fully amortizing with terms under 30 years, and fees and points not exceeding 3%. With over 2 million homes still in foreclosure, 6 million in default, and 10 million underwater, the margin for error may not be optimal. And in an unanticipated twist, Fannie is financially back on its feet, now the country’s third most profitable financial firm, earning $17.2 billion in 2012, just behind JPMorgan Chase and Wells Fargo! We’re continuing to see debate over whether profit from the GSE g-fees can and should now be used for other government spending, including a new proposals that it should not.
Our world, our country and even average Americans have changed since FHA, Fannie, and Freddie were first created. No doubt changing with the times and learning from mistakes is as important as giving these entities credit where credit is due. But at the end of the day, the debate over the future of FHA, Fannie and Freddie boils down to one question: what is the appropriate role for government in housing finance? There are sound economic reasons why homeownership has always been a cornerstone of the American Dream. Dollar for dollar consumers can certainly make more money investing elsewhere if they have the time, discipline and sophistication to do so—but most do not. Homeownership is in essence a forced savings plan. Without it, how will average Americans accumulate wealth to pay for things like college and retirement? Because if they can’t as taxpayers, we’ll all wind up picking up those bills. Already the number of households owning homes has fallen to around 74 million, its lowest rate since 1995 and that is predicted to drop to 64% in the near future, adding about 9 million more renters to the marketplace, as an estimated two-thirds of newly formed households choose to rent rather than own. The largest decline is among folks age 35 to 45, critical financial future preparation years. As we speak, multiple funds are investing billions of dollars targeting certain areas and buying up homes to rent, essentially banking that millions of Americans will choose—or due to housing finance reform be forced into—renting over owning in the next five to 10 years. All of this could have a negative impact on American homeownership, everybody’s home values and the housing market in general. And then there’s the issue of making sure mortgage loans are available in a crises like we just had—that’s a role government will probably always have to fill.