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Blame Game
October 09, 2008
The ongoing economic calamity has brought out plenty of bad attitude. But it's hard to top this rubbish from Ann Coulter's blog with the subtle title, They Gave Your Money to a Less Qualified Minority:
"This crisis was caused by political correctness being forced on the mortgage lending industry in the Clinton era.
"Before the Democrats' affirmative action lending policies became an embarrassment, the Los Angeles Times reported that, starting in 1992, a majority-Democratic Congress "mandated that Fannie and Freddie increase their purchases of mortgages for low-income and medium-income borrowers. Operating under that requirement, Fannie Mae, in particular, has been aggressive and creative in stimulating minority gains.
"Under Clinton, the entire federal government put massive pressure on banks to grant more mortgages to the poor and minorities. Clinton's secretary of Housing and Urban Development, Andrew Cuomo, investigated Fannie Mae for racial discrimination and proposed that 50 percent of Fannie Mae's and Freddie Mac's portfolio be made up of loans to low- to moderate-income borrowers by the year 2001..."Now, at a cost of hundreds of billions of dollars, middle-class taxpayers are going to be forced to bail out the Democrats' two most important constituent groups: rich Wall Street bankers and welfare recipients.
"Political correctness had already ruined education, sports, science and entertainment. But it took a Democratic president with a Democratic congress for political correctness to wreck the financial industry."
It's hard to imagine a baser, more racist approach to this crisis. Never mind that minority homebuyers and the neighborhoods where they live are among the biggest victims in this mess. Never mind that the Congress was firmly in Republican hands for much of the last 8 years, and that the Bush Administration has had control over the regulatory agencies for all of them. In Coulter's world, Democrats and their handmaidens led the economy over the cliff by diverting "your" money to "those people." Willie Horton, phone home.
There has been a steady chant across the conservative blogosphere blaming everything from CRA to Fannie Mae and Freddie Mae to low income and minority borrowers for the current crisis. Apparently any participant in the market will do for these critics except the real culprits - unregulated, fee-crazed brokers, Wall Street securitizers, and the mortgage bankers who facilitated the transfer of the latter's money into the former's hands. Why aren't we hearing about Ameriquest, Option One, New Century and all the other lenders who had to settle with various state attorneys general over their abusive lending practices before vanishing in a mushroom cloud of exploding subprime mortgages?
Why don't so-called conservatives focus on the real abuses in the originations market that ballooned into a repayment crisis? Like:
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Loans where you don't have to state your income?
- Loans where you can't possibly qualify for the rate in Year 3, after the first two years' teaser rates vanish?
- Loans for homes sold like loans for cars, as in "how much could you pay a month for this house? Okay, I can do that for you."
- Loans with prepayment penalties that make it nearly impossible to refinance the loan if needed?
- Loans that look like they have 20 percent down payments where there actually are other, even more expensive loans added on top to cover this?
Coulter, like many other conservative commentators, blithely ignores how bipartisan the push to increase homeownership was. Increasing minority homeownership was a priority for the Clinton HUD. And it also was one of the cornerstones of President Bush's "Ownership Society." The housing goals Coulter references were hiked much higher by the Bush Administration in 2004 than in 2000.
I happen to think that the broad intent of the efforts to increase minority and low-mod participation in homeownership was laudable. Others may disagree. But it's absurd and misleading to assert, as Coulter does, that it was a partisan issue in the first place.
She's also wrong about regulation. Subprime lenders were not responding to regulatory pressure. They weren't subject to any. They were almost entirely outside of the banking regulatory structure. Some of their business came from borrowers who could have qualified for much better terms with a prime, conventional mortgage. But brokers could make a lot more in fees by selling subprime products. So that's what they sold. As house prices continued to escalate, these lenders began adding more and more layers of risk to qualify borrowers and keep their own paychecks coming. Other borrowers were victimized by unscrupulous lenders who defrauded them and the investors who bought the mortgages.
When states did try to impose regulatory constraints, subprime lenders fought back relentlessly. When Congress considered a federal response, they did everything they could to stymie that, too. Federal regulators belatedly imposed new guidance on banks in 2006, after many had acquired subprime subsidiaries or were themselves following the herd into these risky products to maintain market share. Among these new rules was a directive to lend only where there was a reasonable expectation that borrowers could repay the loan. This seems like common sense. But by then the bubble was almost fully inflated, and the damage had been done by lenders who had not followed that simple rule.
There are plenty of good rebuttals to Coulter's and others' nonsense throughout the Web. Here are some recommended samples:
Ellen Seidman at New America Foundation
This cogent Atlantic Online piece documents the organized efforts by Republicans to try to pin this crisis on anyone but the Bush Administration. For a mordantly funny take on all this, download this cartoon. It's a Word document, and will take a few moments to download. But it's worth it.
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Game Over?
September 07, 2008
Treasury Secretary Hank Paulson, Fed Chairman Ben Bernanke, and FHFA Director James Lockhart announced on Sept. 7 that the US Government is taking Fannie Mae and Freddie Mac into conservatorship until further notice.
Say, Hank, is that a bazooka in your pocket, or are you just glad to see us?
The government acquired $1 billion in senior preferred stock in each company, with a 10 percent interest payment, and 79.9 percent interest in their outstanding common stock through warrants. The companies' CEOs were dismissed and replaced by two finance industry veterans. The government pledged to buy Fannie and Freddie guaranteed mortgage backed securities (MBS) while allowing their portfolios to grow through 2009. After that, however, both would have to start shrinking their portfolios by 10 percent a year until reaching $250B.
On Monday morning, Sept. 8, investors rushed to the exits to dump both companies' outstanding common and preferred stock. Fannie alone traded more than 332 million common shares in the first few hours. The daily average is under 80 million shares. The price dipped below $1 per share midday.
Why the Rush?
The best explanation I've heard for why the government moved in on both companies with such unexpected speed is that both Treasury and the Fed were being told by foreign investors, especially but not only China, that they had no appetite for more of the GSEs' debt offerings without an explicit move by the government. These investors also were net sellers of the debt recently, driving up the GSEs' borrowing costs, keeping mortgage rates higher than other rates infuenced by the Fed, and raising the specter of a total meltdown in their debt cycle.
After that the GSEs' newly strengthened regulator, backed by new work they commissioned from Morgan Stanley, told both companies they were exercising their conservatorship powers and that was that.
I've reviewed the materials provided by the government over the weekend and have the following thoughts about this unprecedented move.
Pros
- The plan will reassure domestic and overseas debt investors and keep capital flowing into the housing market when it is critically needed.
- Fannie Mae and Freddie Mac remain the most important sources of mortgage capital in the US market at this time. The proposed plan will enable them to continue to provide this important liquidity function. There are no other financial entities that have indicated any ability or inclination to fill this need, and the government has no other ready mechanism to do it directly. This plan will help keep the mortgage system operating through an unprecedented difficult period.
- Actual taxpayer funds contributed to shore up the companies' capital structure will be invested only as needed after the initial $1 billion in senior preferred, with its premium return. Common shareholders are last in line for any reward. All dividends to other shareholders have been suspended. The market already (on Sunday, 7 Sept) has marked down outstanding preferred and common stock, hardly a bailout. Common shareholders already have lost 90 percent of their value from a year ago, and preferred shareholders have lost nearly half the value of their holdings. In return for the initial $1 billion investment, the US. Government has obtained warrants for 79.9 percent of the outstanding common stock. The 2008 GSE book of business is being underwritten at higher fees and higher credit quality, creating the basis for financial recovery that likely will enable them to stablize and cover any costs to the taxpayer the plan involves.
- The planned Treasury purchase of MBS will provide an important liquidity backstop if the companies' capital positions and participation by other investors limit the ability to make a market for the MBS.
- The promised renewed focus on the companies' mission is important and welcome.
- Retaining the companies in their current form will allow them to continue to carry out their liquidity purposes, leverage the deep competencies in their professional staffs, and give the government substantial depth in navigating the difficult course that lies ahead. The US Government just gained control over nearly 10,000 very competent staff who will continue to be paid through the companies' own operations, not the taxpayer.
- This stabilization will give the next Administration and Congress breathing room to thoughtfully consider what form, if any, government sponsored enterprises should play in the mortgage markets in the future. It does not foreclose any options, but maintains their important functions while those considerations take place. The announced ban on lobbying by the companies takes them out of the future discussion except as technical resources to the conservator.
Cons
- While the renewed focus on the companies' mission is welcome, how this will be defined remains unclear. There needs to be more clarity on how large a role serving the mortgage needs of low, moderate and middle income homebuyers.
- Fannie and Freddie are the dominant source of mortgage capital for multifamily housing. It is a solvent and profitable business for both, with minimal losses. Any moves by the conservator that negatively affects this will further decrease the flow of capital to housing that serves the low and moderate income market.
- The companies' policy to delay taking delinquent mortgages out of pools and to continue paying principal and interest to investors has provided room for workouts and modifications. If the conservator's plan curtails this practice there could be an uptick in defaults and foreclosures.
- The announcement suggests that the current fee structure will be reviewed. The higher fees now being charged are an important source of new revenue to help the companies offset losses. Some portion of these losses is clearly the result of poor credit quality in the companies' own books. But a much larger portion of their losses is the indirect result of reckless lending by banks and poor regulation by the government that allowed housing prices and homeowner leverage to get out of hand, leading to the deflation of a property value bubble that has depreciated all of their assets, performing and not. As big as Fannie's loss rates are, they remain significantly below those of the industry in general and subprime and private label Alt-A lenders in particular. Reducing their revenue stream now will extend the time it will take to rebuild their capital, which in turn will extend the likely term of a conservatorship. On the other hand, the higher fees are making mortgage credit more expensive for low and moderate income buyers with good credit. A balance must be struck between these two outcomes.
- Curtailment of the companies' charitable giving will hit community partners hard. Many of these are on the front line of helping to stabilize communities struggling with the mess created by non-GSE subprime lending. None of the investment banks or others that willingly provided liquidity for this reckless lending are being forced to pay for this community damage. The announcement does not specify what will happen to the projected GSE contributions to the "Affordable Housing Fund" that is supposed to backstop FHA's new mortgage initiative, and later provide funding for desperately needed affordable housing for extremely low income households. If the government plan wipes out these funds, FHA losses will have to be made up by taxpayers directly.
- The announced intention to force the companies' portfolios into an annual 10 percent reduction to $250B each begs the question of what sources will make up this difference, or why it is sensible, wise or necessary prior to determining the best future course for the system. There is no rationale offered for why $250B is the right goal. This seems like an ideologically driven feature that predetermines the outcome of Congress' future decisions. There is no analysis offered of the market's ability or willingness to absorb the share that the GSEs would shed. It's unclear why having the US Treasury become the largest and/or last resort buyer of MBS in the US market is a smart or desirable move.
- The GSEs should give high priority to community stabilization and preservation in their sales of REO from foreclosed properties. The announcement is silent on how the conservatorship will affect this function. If the GSEs do not forego potential income from these sales through discounts to insure homewners, not investors, and communities with effective plans for how to acquire, stabilize and steward them, the costs of foreclosures will simply cascade down to state and local governments and further erode the home values of neighbors who are not yet in trouble. The conservator must balance these needs against that of raising money to offset losses to the GSEs from foreclosures.
- Both Fannie and Freddie have made enormous contributions to affordable rental housing through their past investments in Low Income Housing Tax Credits. Quickly exempting these credits from the companies' AMT limits would improve their capital position. Congress recently exempted going-forward LIHTC losses from AMT. Forcing the GSEs to write off the accumulated credits would be a perverse reward for being the single most active participants in this market in the past.
What do you say now, dear?
If any politician asked me, this is what I'd suggest s/he say about these events:
- The announced plan is an unfortunate turn of events. But with serious doubts about buyers' willingness to remain in the GSE debt market, it should stabilize the most important source of capital for American homebuyers and homeowners.
- Congress and the next Administration must take quick action in 2009 to use the breathing space this initiative creates to carry out a serious and sober reassessment of how the mortgage system should be restructured to ensure the continued flow of capital without jeopardizing the taxpayer. The needs the GSEs were chartered to meet -- standardization, liquidity, and access in the mortgage market -- remain critically important.
- The public-private GSE model functioned extremely well for 40 years. It has provided access to long-term, fixed rate mortgages at a scale unrivaled anywhere else in the world. This has been critical for low, moderate and middle income consumers by providing them with stable, affordable means to buy and maintain their homes. While it may need significant reform, we should not assume that it cannot be designed, regulated and managed to work well for another 40.
- While Fannie Mae and Freddie Mac have become the largest and most critical victims of a "Wild West" system of under-regulated, over-stimulated primary market lending, no reform of these two companies will succeed without a serious and significant overhaul of how the primary market is regulated to protect consumers.
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Where Has All The Money Gone?
July 15, 2008
It will take years to sift through the mortgage market's wreckage before we know all the details behind its collapse. But public policy can't wait that long to draw some conclusions about the role played by low down payment home loans to people of modest means. This is of particular importance to federal bank regulators, who are responsible for enforcing the Community Reinvestment Act (CRA), and to whoever turns out to be the regulator for Fannie Mae and Freddie Mac with authority over their housing goals.
Plenty of commentators have suggested in the last year that more aggressive lending to people with lower credit profiles and little or no money to put down are drivers of the crisis. But at least two sources of information suggest that while these borrowers' performance has been poorer lately than in prior periods, it was other types of lending to different types of borrowers that is putting the hurt on lenders, investors and guarantors.
Fannie Mae built one of the largest portfolios of community lending assets in the country in the last 20 years. Starting with its Community Home Buyers© products offering the first standardized 5 percent and later 3 percent down payment products, the company expanded and tweaked these products until it incorporated its My Community Mortgage© product into its Desktop Underwriter© automated underwriting software in 2006. From 1996 until 2006 I oversaw much of the development work on these products.
In 1998, Fannie Mae joined with the Ford Foundation and the Self Help Ventures Fund to launch the Community Access Program, an owner-occupant mortgage lending partnership aimed specifically at low-and moderate income, low wealth households. Ford also funded a separate ongoing research effort at the Center for Community Capital at the University of North Carolina to provide a rigorous evaluation as the program evolved.
In a presentation prepared for a Neighborworks America symposium in Cincinnati in May, 2008, the Center's former director Michael Stegman summarized some of the ongoing research's findings on performance of these loans. Comparing their performance from the beginning of the program in 1998 through September, 2007, the UNC research shows that the Community Access loans experienced 90+ day delinquencies (where the borrower fails to pay for at least three months) at rates that were higher than prime fixed rate mortgages, but significantly lower than FHA-insured loans, subprime fixed rate loans and subprime ARM loans. Compared to subprime loans, Community Access loans were significantly slower to show the first 90+ day delinquencies than either fixed or adjustable subprime loans, and in later years of the program significantly slower than prime, fixed rate loans. This performance held pretty steady until 2006, when these trends showed a marked deterioration, with the 90 day delinquency rate rising much faster than it had for earlier "vintages," but still significantly better than subprime loans from the same period.
It was assumed at the time these loans were underwritten that they would not perform as well as prime loans, and they did not. Pricing decisions were made on those assumptions, and they seem to have been borne out. What the analysis also shows, however, is that well underwritten loans to people of modest means with low down payments far outperformed subprime loans issued during the same periods.
More Data
The other interesting source of information about loan performance is Fannie Mae's quarterly investor information summaries, the latest of which was released in May, 2008. One table in particular, titled "Fannie Mae Credit Profile by Key Product Features (page 24 in the linked file), offers some tantalizing insights into Fannie Mae's losses.
The table does not allow a direct evaluation of the company's community lending products. It only offers partial slices of data. So, for instance, the table shows that the company has a total single family credit book of $2.606 trillion, and within that a $128.1 billion credit exposure to loans with credit scores below 620 (the usual cut off before moving into subprime borrower territory, and the cut off for any loans under the My Community Mortgage© product). This was 4.9 percent of the total credit exposure, but accounted for 14 percent of the credit losses in the first quarter of 2008. That's a multiple of slightly less than 3...not good, but certainly not enough to blow them up with such a relatively small base.
Similarly, the table shows that Fannie had $258.6 billion in loans with down payments of less than 10 percent. That was 10.3 percent of the credit book, but accounted for 17.4 percent of the first quarter credit losses. That's a multiple of about 1.7.
Loans with credit scores below 620 and less than 10 percent down accounted for $30 billion, or 1.2 percent of the credit book, but 6 percent of first quarter credit losses. That's a multiple of 5. This is not too surprising when you combine crummy credit histories with low down payments.
So far the story seems to be that loans at the "tail ends" of the credit spectrum are doing more poorly than their share of the total would suggest.
Liar, Liar, Loan's on Fire!
But the table also accounts for Alt-A and subprime loans. The latter made up a very small piece of the credit book, only $8 billion, or 0.3 percent of the book, and 1.4 percent of the losses. Around a multiple of 4, but a very small nominal amount.
Alt-A, on the other hand, accounted for $310.5 billion, or 11.2 percent of the total credit book of $2.6 trillion, but....wait for it....42.7 percent of first quarter credit losses. That's a multiple of nearly 4 on a helluva base. Compare this to the low downpayment loans - 10 percent of the credit book, but only 17.4 percent of the losses.
Alt-A loans were supposedly made to people with good credit but with special flexibilities, like income that was reported but not verified, or no stated assets, and so on. They seldom had mortgage insurance (only 40 percent did, according to this table, compared to 92.7 percent of those with less than 10 percent down), which means Fannie Mae is much more exposed to losses from these loans. They also tended to be much higher balance loans, often were accompanied by separate second mortgages from other lenders that actually drove up the overall LTV, and were concentrated in states with rapidly escalating and now falling home prices.
These loans have become known in the industry as "liar loans." As in, lied about income, lied about assets. Bankers forgot a key principle of the Reagan era - trust, but verify. The cratering performance of these loans is one result.
Fannie Mae's table doesn't analyze the loans by exclusive category; many loans fit into more than one. Low credit score and low down payment loan numbers are partially or fully included in the Alt-A numbers, and vice versa, so comparing the ratios is not totally apples to apples.
A Little Knowledge...
These numbers are tantalizing, but ultimately frustrating, because they still do not allow a reliable analysis of how the products most specifically targeted to low wealth, low income borrowers are performing and what share of Fannie Mae's losses they account for.
Likewise, there is no public information available to analyze the performance of billions of dollars of specialized loan products that regulated banks put on their books to help them comply with Community Reinvestment Act (CRA) requirements.
My colleague and former Fannie Mae-er Ellen Seidman has disposed handily of suggestions that CRA is the root cause of the mortgage market's meltdown. I support her analysis 100 percent. But all of the contextual facts still do not answer the very important question of how the loans made to satisfy CRA requirements - or for Fannie Mae, their legislative housing goals - actually are performing and what lessons regulators, lenders and advocates should be learning from the last 20 years' experience.
There are no published data from banks about their loan performance, just as there is scarce product line information from Fannie Mae and Freddie Mac. It would be in the regulators' and the public's best interests to find a way to get this information from the lending community in order to shape the regulatory environment based on actual facts rather than self-serving or uninformed assertions. OFHEO could do this analysis on Fannie and Freddie's books. The OCC and the Fed could do it for regulated banks.
For the long term, what's puzzling and sobering is that having invested so much time and effort in these initiatives, regulators and industry have so little information about the performance of these loans. Fixing that gap would be a good goal for the next Administration.
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Get Me Rewrite!
July 14, 2008
Among all the depressing lowlights of last week's stock run on Fannie Mae and Freddie Mac, the terrible quality of the coverage by nearly every outlet I encountered rates right at the top. Because I remain a Fannie Mae shareholder, I tried to follow this pretty closely. I even watched some cable financial news coverage, something I never do, and I hopped through Google and Yahoo Finance hourly.
Night after night, morning after morning, news outlets focused on the two GSEs, and not in a good way. Rightfully so, because it was a big story: two Fortune 500 companies that have become practically the only source of mortgage credit suffer staggering losses in their stocks, costing shareholders tens of billions of dollars and conceivably crippling both companies.
But why did this happen? What drove investors to rush out of these stocks?
Got Any Facts?
If you were a common investor with only a rudimentary understanding of these companies and relied on the mainstream media for information, the message went something like this: Fannie and Freddie are finally being held to account; decades of subterfuge and political management have finally yielded to an informed marketplace that realizes the two companies are in such terrible trouble only stupid investors are going to hold onto the stock; the two Washington, D.C.-based emperors of housing finance have no clothes; this is like Bear, Stearns all over again and the companies are facing insolvency; the federal government is going to have to take them over, taxpayers are about to take it in the kishkes.
Over the weekend the press hyped the story further and borrowed from their sports divisions by painting Freddie Mac's planned Monday(July 14, 2008) debt sale as a capital markets death match on which the health of the US economy hinged. These stories typically did not point out that Fannie Mae had only days before handled a similar issuance without a hitch, and at a lower cost than one they had held the week before. Such facts might have diluted the dramatic quality of the coverage, I guess. As it turned out, Freddie went to market on Monday without any problems.
The press never explained what caused the rout. Indeed, it seemed almost disinterested in the underlying dynamics. Was it a profound and sudden shift in the company's fundamentals? Had either one suddenly found itself cut off from the debt markets that are essential to fueling their day to day purchase and securitization of mortgages? Were either one in imminent danger of failing their statutorily set minimum capital amounts?
If you consulted some investor reports, read the latter day statements from Treasury Secretary Paulson, or the GSEs' regulator James Lockhart of OFHEO, the answers to these important questions appeared to be...no, no and no.
Late in the week the two companies belatedly released statements confirming this. They pointed out that their debt costs had actually declined in the prior week. They noted that their most recent debt issuances were oversubscribed. They emphasized that they were in compliance with all regulatory capital requirements, and had tens of billions of capital on hand.
Even the Lehman report on a new FASB accounting rule that sparked the rout by noting the rule could conceivably require Fannie and Freddie to dramatically increase their capital to account for assets now held off their balance sheets noted this was a remote possibility, and OFHEO Director Lockhart quickly dismissed the speculation as unfounded.
So what caused the run? Why were investors fleeing the stock? Inquiring minds want to know.
Good News is No News?
News outlets did endlessly note that the two own or securitize more than 70 percent of current originations, but then moved on without much insight. If you looked hard, you could find an isolated reference or two to the fact that these assets are being booked at much higher fees than in the past, and that tightened underwriting means these will be of higher quality than older loans.
In other words, here are two companies whose regulator says that they are not suffering a liquidity crisis; that have adequate capital; that currently own their markets outright and are booking enormous amounts of new business; that have been able to increase fees that will provide income flow for years to come; and that have increased the quality of those assets and thus the likelihood that the higher income streams will be there in the future.
So with these fundamentals in place, why would their stocks lose more than half their value in a few short days? Believe me, I am dying to know.
It would have been nice to have found a mainstream media story that actually pondered these issues and illuminated them. But instead the public was treated to a lot of information but little insight.
The New York Times' Sunday news coverage of the affair amounted to little more than a rehash of old stories and quotes from long-time critics.
Jim Cramer was highlighted on endless loops of video declaring both companies dead. He was never pressed to explain exactly why or how. But he must have been delighted to have his opportunity to look glum and declare the need to nationalize both companies.
On Kudlow and Company on Thursday evening, the final word came from a commenter who asserted that the week's lesson was that Fannie and Freddie have been "crowding out" banks and it's high time they were pushed aside to allow the free market to work. Never mind that there isn't a bank on earth today that will make a mortgage loan in the US that it does not believe Fannie or Freddie will ultimately invest in or securitize.
This is what passes for informed commentary.
Sunday (July 13, 2008) evening's White House announcement of special steps the government is prepared to make seem to have calmed the market. But the question that remains unanswered by mainstream press coverage still remains, why did the market dump these stocks in spite of all these facts?
Maybe there are underlying, terrible facts about the GSEs' balance sheets or management that will yet come to light and justify the vaporization of so much market value. As a shareholder I certainly hope not, but if it is I'd rather know why the end is near than be treated to mere assertions that this is so.
But maybe instead we'll learn this was an old fashioned run on two stocks driven by short sellers and panicked sellers, abetted by a press corps that would rather cover the race than uncover the facts. Perhaps not coincidentally, the SEC over the weekend announced a new probe into the use of falsehoods and rumors to manipulate stock prices. It will be interesting to see how the press covers that.