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In a climactic scene of 1974's noir classic "Chinatown,"  Jack Nicholson's character LA private eye Jake Gittes is confronting Faye Dunaway's character Evelyn Cross Mulwray.  Gittes demands that Mulwray explain the identity of the little girl she is trying to spirit out of town. 

"She's my daughter," Mulwray says.  Gittes slaps her hard.

She's my sister," Mulwray says, and Gittes slaps her again.

"She's my daughter."  Slap.  "She's my sister."  Slap.

And so on.  The horrible truth is that the girl is Mulwray's daughter and her sister through an incestuous relationship with her father.  It's the capstone image of the cesspool of corruption into which Gittes has fallen while investigating water deals in post-war Los Angeles.

My Sister

This is the image that's been running through my mind this week.   Fannie Mae's and Freddie Mac's new regulator announced that while both companies were adequately capitalized, they were not adequately capitalized and anyway, from now on FHFA won't worry about whether they're adequately capitalized or not.   According to the October 10, 2008 Washington Post,

"Fannie Mae and Freddie Mac had said at the end of June that they had billions of dollars more of a financial cushion than required by their regulator. The report by the Federal Housing Finance Agency yesterday reaffirmed that, saying Fannie Mae had $9.4 billion and Freddie Mac had $2.7 billion more capital than required.

"But, even though the companies were adequately capitalized, the regulator yesterday declared them undercapitalized.  How did it square that circle?

"The regulator, in essence, said capital wasn't a good enough barometer of the companies' financial footing. The law gives the regulator the authority to designate the companies undercapitalized even if they technically have enough capital. In its report, the FHFA said that the sharp downturn in the mortgage market over the summer ‘raised significant questions about the sufficiency of capital.'

"...Usually, being declared undercapitalized would subject the companies to modest penalties, but none will be exacted while they are under government control. The FHFA also has suspended the capital requirements, though the companies will continue to disclose capital figures in their quarterly reports. The government set up a program to lend money or inject capital if the companies falter. "

Note that although the conservatorship came with authority to inject up to $200 billion into the two companies to shore up their capital, to date not one dollar has been invested.  The companies continue to operate much as they did before the takeover, without any taxpayer money so far being spent.

That could change in a hurry, though, because FHFA also announced this week that it is wrenching them back into the portfolio lending business.  But this time, the regulator wants to make sure they buy junk.

My Daughter

Earlier this year FHFA Director James Lockhart said repeatedly that Fannie and Freddie's portfolios were not needed to help stabilize the markets or carry out their mission.  Both companies, he said, had ample opportunity to guarantee securities backed by mortgages and let other investors buy them.  GSE bashers from all sides opined that their portfolios were a prime source of the credit crisis, that they were unnecessary vestiges of a bygone era, and had permitted the two companies to borrow huge amounts at discounted rates to re-invest it to buy mortgage securities in a market that didn't need them.

Since then, Fannie and Freddie have been practically the only source of capital in the mortgage markets.  When Freddie announced it had shrunk its portfolio by more than $30 billion last month, shivers went through the markets because of the sudden prospect of even less liquidity for mortgage debt.

Secretary Hank Paulson said that they would increase their portfolios by a modest amount over the next 18 months when the US Treasury and FHFA forced the two companies into conservatorship in September.  After that, he expected them to be reduced over 10 years to around $250 billion each.  They are both presently at a about $760 billion.  At the time, I wrote that "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."

Now this week, Bloomberg's Dawn Kopecki reports that

"Federal regulators directed Fannie Mae and Freddie Mac to start purchasing $40 billion a month of underperforming mortgage bonds as the Bush administration expands its options to buy troubled financial assets and resuscitate the U.S. economy, according to three people briefed about the plan.

"Fannie and Freddie began notifying bond traders last week that each company needs to buy $20 billion a month in mostly subprime, Alt-A and non-performing prime mortgage securities, according to the people, who asked not to be identified because the plans are confidential. The purchases would be separate from the U.S. Treasury's $700 billion Troubled Asset Relief Program."

Now that the government owns them, it seems that their portfolios are not only useful tools in a credit-starved marketplace.  They are  handy tools to purchase junk. 

Some folks who ought to know tell me on Monday, October 13, 2008, that this report is unfounded.  I hope so.  But so far there has been no retraction on Bloomberg and no disclaimer from FHFA, Treasury or anywhere else that I could find.  If it's not true, someone please stand up and say so!

This news comes at the same time the Treasury is reported to be reconsidering the $700 Troubled Asset Recovery Program (TARP) it just got Congress to approve.  Treasury apparently won't be haggling with Wall Street banks and others holding this toxic crap to force a cramdown.  Instead, it seems that Treasury will buy shares in banks and Fannie and Freddie will lighten their debt load using their now-government guaranteed portfolios.

It's Chinatown, Jake

So, to recap: 

During most of 2007-08, Director Lockhart used his authority under settlement agreements with both companies to limit their portfolio growth through requiring both to hold penalty levels of capital.

When Congress pushed to allow their portfolios to expand, Lockhart and others responded that they could issue mortgage backed securities instead.

In September, Lockhart triggers new conservatorship powers asserting that they are in danger of being undercapitalized.

A month later Lockhart acknowledges that they actually both have sufficient capital according to the standards laid out in law and administered by Lockhart himself.  But he announces these measures are actually no good, so the companies had to be taken over anyway.  Lockhart questions whether certain assets claimed by the companies are really valid.  Although the companies are using the same generally acceptable accounting principles (GAAP) that everyone else does to value these assets, Lockhart decides these may not be good enough to rely on.  Footnote here:  can you remember what happened the last time someone suggested that GAAP accounting rules weren't being followed at the GSEs?  Can you say, "fired?"

In October, without having spent any of the funds set aside to shore up the two companies, Lockhart apparently has decided that both should dive back into the portfolio lending business big time, and start making a market for bad mortgage assets stuck on others' books. 

No wonder Fannie and Freddie must feel like poor Evelyn Mulwray.  Slapped this way, slapped that way.  What's a girl to do?

But as the man in the movie says, "forget it, Jake, it's Chinatown."

 

 

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:

• 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:

The Big Picture

Ellen Seidman at New America Foundation

Business Week

David Abromowitz

Newsweek Online

McClatchy News Service

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.

 

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

1. The plan will reassure domestic and overseas debt investors and keep capital flowing into the housing market when it is critically needed.
   
2. 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.
   
3. 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.
   
4. 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.
   
5. The promised renewed focus on the companies' mission is important and welcome.
   
6. 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.
   
7. 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

1. 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.
   
2. 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.
   
3. 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.
   
4. 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. 
   
5. 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.
   
6. 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.
   
7. 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.
   
8. 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.

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.

 

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.

 

The comprehensive foreclosure relief and GSE reform bill has finally passed the U.S. Senate, after an embarrassingly long floor debate.  It now heads for an inevitable conference with the House over differences in several areas.  And the White Houses's 11^th hour request on July 12 to add new authorities to back up Fannie Mae and Freddie Mac promises to make the final discussions even more stressful.

It's ironic, then, that one of the centerpieces of the new legislation in both houses is the establishment of an "affordable housing fund" to be financed through a new tax on the two GSEs. 

The so-called "Housing Trust Fund" established by the Senate's Federal Housing Finance Regulatory Reform Act of 2008 would require 4.2 basis points of both Fannie Mae's and Freddie Mac's new business to be diverted into a fund.  The idea to require both Fannie and Freddie to devote a specific amount each year to develop and preserve affordable housing is terrific.  Properly structured and designed, such a requirement could force the GSE's into more active and meaningful participation in affordable housing preservation and development.  It would leverage the unique position the two companies occupy in the housing finance system. 

But the trust fund in both the House and Senate bills instead turns Fannie and Freddie into piggy banks, siphoning off money from their operations to provide cash for others.   This is like leaving a high powered luxury automobile parked in the back yard to use as extra seating for barbecues.

The Senate bill adds insult to injury by requiring the funds in the first year after authorization to be devoted to paying the costs of a new FHA mortgage insurance scheme designed to help struggling homeowners escape crappy subprime mortgages.  Instead of bringing the substantial power and expertise of the GSEs to create new value for residents and communities, the bill turns them into the funders of FHA's full faith and credit guarantees that help subprime lenders unload their soon-to-be-nonperforming loans onto the FHA, where many may fail anyway in spite of better terms. 

This is especially ironic considering that the White House now asked Congress to give it the authority to explicitly back Fannie Mae and Freddie Mac.

This perversion of the affordable housing fund idea was promoted by Banking Committee Ranking Member Sen. Richard Shelby (R-AL) and other Republican members.  Thus the  Senators expressing the most concern over the GSE's ties to the federal government are the ones to make them the FHA's banker!

The House-passed GSE reform bill also establishes a fund.  Its version would divert the money first to Hurricane Katrina needs, and then to a "National Affordable Housing Trust Fund" to provide capital for extremely and very low income housing. 

Housing advocates cried foul over the Dodd-Shelby "highjacking" of the trust fund.  But anyone who thinks this is the last time Congress will find a more compelling use for this money than a dedicated fund for extremely low income housing subsidies is ignoring the totally unbalanced budget and the looming fiscal crisis that is going to make the Donner party look like a polite little buffet dinner among friends.

How did this happen?  How did advocates struggling with inadequate funding, growing needs for inventive and sustainable approaches to affordable housing preservation and development, and the opportunity to increase the GSE's relevancy and attention to these issues get sidetracked into a bidding war with every special interest and short-term funding need that comes across Congress's radar screen? 

And how did Fannie Mae, in particular, which only 15 years ago was the envy of HUD Secretary Henry Cisneros for its ability to set big goals and bring huge resources to bear on housing problems, find itself cut down to no more than an ATM for every special interest in the housing community?  My short list of reasons follows.

Who's your daddy?

Housing advocacy organizations have splintered off into interest sections, whether for trust funds, state housing agency allocations, technical assistance grants, or CDFI capital.  There is no unifying, strategic voice within the advocacy community that sees past these important but tactical issues to the larger strategic directions of the housing market. 

Thus, Fannie and Freddie become most attractive not for the role they can play in development, but for the cash they can provide to fund other people's priorities.

Sadly, I believe this approach is going to weaken the GSEs' own interest in affordable housing and community development and isolate them further from a strong focus on their missions.  It will foster an attitude of "we gave at the office."   It will embolden those in the companies who think that the companies' mission is a burden to be endured rather than a calling to be embraced, enhanced and pursued.  It is much easier for these companies to write a check than it is for them to actually use economically sustainable strategies to produce and preserve affordable housing. 

In addition, advocates' promotion of this new surtax and Congress' willingness to divert it to the crise du jour will reinforce private equity analysts' view that these companies are in eternal danger of having shareholder value siphoned off to meet funding shortfalls for congressional pet projects or causes.  This will offer a much more limited upside for investors who provide the capital that makes the GESs' world go ‘round. 

Good friends are hard to find

The GSE's have no friends today.  How did this happen?  After more than 15 years of active cultivation of new partners, sponsorship and partnership of new initiatives and programs, and adopting fundamental and progressive changes in underwriting and financing, why are they so isolated today?   When enemies in Congress who adjure the very thought of a government sponsored enterprise layer new, highly restrictive requirements on the companies that would raise their capital and hamstring their ability to innovate, where are the advocates who would benefit from a more active GSE role?

Maybe it's because these companies are complicated, and it's too hard for busy advocates to fully understand.  Maybe it's because their real value always has lain in their key importance to the mortgage finance system, rather than to any one part of it, so that no one feels they "own" the issues.  Maybe it's because large commercial banks and others who are anxious to strictly limit the GSEs so they can maximize their own participation and profit at consumers' expense are also courting public opinion and have left the GSE's erstwhile friends neutered.   Whatever the reason, the lack of strong, strategic and well reasoned advocacy on behalf of the GSEs and their mission is troubling.

Home alone

If the GSE's have no friends willing to speak up for them, maybe it's because of their own alarming unwillingness or inability to speak up for themselves.  The transformation of these companies from swaggering buccaneers to shrinking violets is startling. 

Fannie Mae's and Freddie Mac's own attempts to forge a trust fund design that would enable them to control the funds and use them to leverage their other investments were hesitant, conflicted, and ultimately too late.  In order to avoid aggravating their newly empowered regulator, they have withdrawn into a haze of "no comment" and no self promotion.  Humility is a virtue, and it was definitely in short supply during the 1990s and early 2000's. 

But an excess of timidity in the pursuit of tranquility is no virtue, to badly paraphrase Barry Goldwater.  Maybe there's much more going on behind the scenes than an outsider like I am now can appreciate.  But their lack of clear public leadership and advocacy on their own behalf has given their former friends and colleagues a free pass to decamp from the battlefield, as well.

Roll the dice

Because both the House and Senate have cleverly tied the new GSE legislation to a modest rescue package for at-risk homeowners, ultimate passage of these bills into law before the election is a virtual certainty.  Others have written with great passion about the new regulatory structure's shortcomings and dangers.  Sober analysts might easily conclude that the country is better off waiting for a new Administration before adopting a new regulatory regime.  The bitter ideological underpinnings of the Bush Administration's GSE policy might be weakened.  A stronger Democratic congressional majority in both houses could make a more reasoned and less vindictive set of policies possible.  But I predict hotter heads will prevail.  Congress is sick of more than four years of considering these bills.  The GSE's seem resigned and more anxious to have this water torture ended than to expend scarce political and regulatory capital on a principled stand. 

Advocates will get their "trust fund," minus the funds for now.  And the housing community will have missed a major opportunity to reshape the most powerful economic forces in the housing economy into a more progressive and active partner.  It's a roll of the dice on an uncertain future.  Let's hope it doesn't come up snake eyes.

 

 

 

This hysterical powerpoint presentation entitled "The Subprime Primer" has been making the rounds through the Internet.  I wish I knew who had authored it so I could give them credit!

Warning:  there is some crude language in this presentation that could trigger corporate firewalls/security/filters.

Government housing programs have a long history of flaming out shortly after being launched.  Rising costs, corruption, scandals, mismanagement and popular opposition have all contributed to an average housing assistance program life span of only about 7 years, according to Charles L. Edson, one of the deans of Washington's assisted housing bar.

So when the Low Income Housing Tax Credit (LIHTC) was adopted in 1986, there was no reason to think it would fare any better. 

But the program has not only outlived the average, it has thrived for more than 20 years.  It was and remains the only significant federal construction and rehabilitation tool in the federal kit.  In return for putting up equity to help build or renovate the affordable rental housing projects, investors get 10 years' worth of tax credits to lower their tax bills.  The program is estimated to support as many as 100,000 units per year.

Now, however, it is beset by problems on both the investor and sponsor side. Fannie Mae and Freddie Mac have long been the largest users of the tax credits, accounting for between 30 and 40 percent of demand.  Other corporations make up the balance.  With real losses from bad loans and investment debts wiping out profits, Fannie, Freddie and others now find themselves with billions in tax credits they cannot use.  They are out of the market for the foreseeable future. 

On the operations side, rents in tax credit properties are fixed as a percentage of the area's median income.  After years of rising every year, these are now falling in many areas.  At the same time, energy and other management costs are rising, threatening a widening gap between rental income and expenses. 

These two new developments are squeezing the tax credit program from both ends.  Whether the program and the existing properties can survive these two challenges may be the most important affordable rental housing question confronting the next Congress and Administration.

Supply and demand drive down yields

The sudden and unprecedented shortage of investors has driven down the price that remaining investors will pay for the credits.  Last year, with credits in high demand, some investors were even paying more than a dollar in equity for a dollar in tax credit value.  Since inflation makes the future dollar of savings worth less than the present value of the purchase, these prices weren't sustainable.  Today, with demand slackening, tax credit prices have fallen to the mid-80 cent range, more in line with historical trends.  While this is good news for investors in the credits, it means that the actual capital available for development expenses in the properties has been cut by as much as 20 percent.  Development costs have not gone down.  So projects are harder to finance when the credits yield less cash.  The rents that owners can charge are capped to insure they are affordable to lower income tenants.  The difference has to be made up by other assistance, or through developers deferring or surrendering altogether the fees they would normally charge for carrying out the work.

Rents vs Costs

One of my first assignments as a reporter in 1973 was to cover a meeting of sponsors of recently built or rehabilitated apartment projects that had benefited from a 1968 housing program called Section 236.  This wildly successful program provided interest rate subsidies to developers in return for restricting rents in the properties.  Tens of thousands of apartments were built under the program. But by 1973, oil prices and inflation had decimated the project sponsors.  The meeting I attended was in a church.  The audience was mostly African-American ministers whose churches were sponsors of Section 236 properties that were going broke because operations expenses were outstripping what they could collect in rents.  You could smell the fear in the room; the mood was one step short of full scale panic.

Thirty five years later this scene could be replayed as tax credit projects face a similar crunch.  The properties developed in the last 20 years have benefited from steadily, if modestly, rising median incomes and low inflation in energy and other key items.  But median income figures compiled by HUD for program sponsors have declined in many markets this year.  At the same time, $110 per barrel oil prices are flowing through the projects' income statements.  Property owners are potentially facing stagnant or even declining rents at the same time their operating expenses are likely to balloon.

In 1973, the threat of thousands of failing apartments led to project-based Section 8 contracts to subsidize rents, and other adjustments and subsidies to re-balance income and expenses at the property level.  The interest rate subsidies could not be increased, and that monthly expense was a fixed cost anyway.  It was the volatility of the variable expenses that did in the Section 236 projects. 

Tax credit properties could be in for the same experience.  The choices facing project sponsors are not easy.  There are only a limited number of potential solutions if the trends continue into the future.  Rents could be increased.  But this would undermine the original purpose of the program, to provide affordable rents to low and very low income tenants.  Subsidies could be provided from other sources, like Section 8 or state housing funds.  But the credit was negotiated in 1986 to restrict the use of such other subsidies, and these restrictions would have to be lifted.  Since housing subsidies are pretty much a zero sum game, this means that other worthy projects would be competing with tax credit properties for scarce funds. 

When the tax credits were first created in 1986, advocates and supporters understood its limitations.  I was one of the principal advocates and architects of the program, and never thought it was more than an incomplete, and relatively inefficient, solution to the problem of subsidizing supply.  But at the time, in the middle of the Reagan Administration's assault on housing subsidies, it was the best we could do.  And it significantly improved on existing tax subsidies that were far less effective at targeting benefits to low income renters.  The peculiar economic climate of the last 25 years has enabled the program to thrive and to put off the difficult choices now beginning to confront owners and advocates.

It looks as if that long honeymoon may finally be over.

The big financial news this week is that the Iron Curtain that was supposed to separate the well disciplined Masters of the Universe in private market investment banks from the girly-men of finance at Freddie Mac and Fannie Mae has turned out to be nothing more substantial than tissue paper.  The Fed joined in a shotgun marriage with JP Morgan Chase to staunch a run on Bear Stearns.   

Can you spell "too big to fail?"

For years now, the members of FM Policy Focus, which includes JP Morgan Chase, and other financial sages, have been beating their breasts over the "moral hazard" created by Fannie and Freddie's special charters and implicit federal guarantee.  As late as last year, Fed officials and OFHEO, the safety and soundness regulator of the two companies, were calling Fannie and Freddie a systemic risk to the financial system.  Investors, they argued, lulled into a stupid trance by the charters, would buy their debt without regard to its risks.  The firms could thereby borrow money recklessly and expand to such a degree that their leveraged positions would threaten the system's stability.

The corollary to this argument was that private sector firms could not rely on such back up and therefore were more soundly capitalized and their debt more carefully scrutinized.

Ooops.  It seems that hell has indeed frozen over.

Fannie and Freddie may pose greater risks to the system than we yet realize.  God knows their economic and accounting losses have been a surprise. 

But while the Fed was sleeping, Wall Street and money center banks went on a credit binge that actually is threatening the financial system.  When one of them got to the brink of insolvency as nervous investors called for their cash, who but the Fed stepped in to save them?

There can be no doubt that Fannie and Freddie's special charters put them in a special position with the government.  Their debt typically trades above Treasuries, but below comparable commercial paper, reflecting the market's higher degree of confidence in its provenance.  They have their own two special regulators and currently are operating under a 30 percent surcharge against their mandatory minimum capital.  They are suffering unprecedented accounting and economic losses.  But no one has suggested that they now need, or are likely to need any time soon, a cash infusion from the government to weather this storm.

But over on Wall Street, these swaggering hypocrites are only too happy to call the government's bluff.  And the Fed, which was wasting its time clucking over the GSEs when they should have been reining in the Street, is putting the government right in the middle of a bailout.

You'd think the folks at FM Policy Focus would be screaming bloody murder over this crude violation of the private sector's credo of "eat lunch, or be lunch."  But when push comes to shove, they were never really concerned about systemic risk.  They were just concerned over how to keep the GSEs from limiting their own voracious appetites for market share and risk taking.

I don't know if the Fed's bailout ultimately is a good thing or a bad thing.  Today's New York Times Business section has a trenchant piece by Gretchen Morgenstern that raises lots of issues.  What's more important to me is the complete breakdown of the fiction that Wall Street -- and probably the big money center banks -- are not as threatening to the financial system as the GSE's, or as likely to be bailed out if they threaten to fail.

Maybe it's just me, but I thought there was some karmic convergence when in the same week Countrywide collapsed into the arms of Bank of America and former Sen. George Mitchell testified in Congress on the doping scandal in major league baseball.

Both events grew out of the same unnerving ability to rationalize anything to get to the top of the game or stay there.  In baseball, world class athletes succumbed to whatever would get them the next homerun or a higher RBI number on their Topps baseball card.  In mortgage lending, former Countrywide CEO Angelo Mozilo pleaded that he and his firm had no choice but to dive headfirst into the toxic lagoon of subprime to keep up with the competition and secure their long cherished goal of being the number one mortgage lender in America.

Greed, hubris and ambition are the common drivers.  What a disheartening spectacle.

But in baseball, at least, you can argue that it's always been the same.  Doping is a time honored tradition.  After all, it was baseball legend Leo Durocher who is credited with dryly noting that "nice guys finish last."  (What he actually said was "The nice guys are all over there. In seventh place.")  In the mortgage business, everyone should have known better.  What kind of world are we living in where the federal banking regulators feel compelled to issue regulations that require banks to follow this simple rule:  do not make a loan to someone that you know they cannot repay?  Isn't this the basic, bedrock principle of banking? 

 

Apparently not.  In spite of many people warning investors, bankers and even rating agencies that the market was badly mispricing risk, brokers, bankers and investors ignored the signs and piled on.  Banking regulators finally adopted that rule and some others to rein in these drunken sailors. But too late for millions of American borrowers and the communities in which they live.

 

The ball players caught up in the scandals are all exceptional athletes and competitors.  They reached the highest levels of their sport on talent and drive.  But reaching even higher was too great a temptation.  So, too, with Angelo Mozilo.  His career in building the Countrywide powerhouse, in helping millions to buy homes and access mortgage credit, and in supporting public efforts to increase access established his reputation.  What a shame that what most people will remember now is the ruins left for homeowners, shareholders, employees and communities from the mortgage industry's own "doping" scandal.

 

Dee Walsh, Executive Director of REACH Community Development in Portland, OR, and Bob Zdenek, Interim Director of the National Housing Institute and former Executive Director of the National Congress for Community Economic Development have published a thoughtful piece in Shelterforce Magazine titled "Balancing Act" detailing the tough choices nonprofits face in deciding whether and how to "go to scale."

This week's announcement of an industry-wide agreement on subprime loan forebearance is a step forward.  But no one, including those who hammered out the deal, thinks it is a solution to the looming foreclosure crisis.  Tens of thousands already have lost their homes; the plan specifically limits its forebearance to a small segment of those affected; and the ability of servicers and lenders to modify individual loans with any real success is very limited.  In short, many, many more families are going to face foreclosure and the loss of their homes. 

 

Housing advocates, funders and government should be focusing much more attention right now on "where the ball is going to be," rather than on where it is today.  And where the ball is heading is to a tidal wave of abandoned homes, particularly concentrated in minority and low and moderate income neighborhoods.

 

At the NTIC conference here in Chicago Thursday morning, a group of panelists including Martin Eakes from Self Help Credit Union and John Rokakis from the Cuyahoga, OH County Treasurer's Office, shared updates on the scale of this crisis.  According to Rokakis, Cleveland has more than 10,000 foreclosed homes already.  The surrounding suburbs, including upper tier places like Shaker Heights, are also seeing large numbers of homes being foreclosed and abandoned.  Eakes shared information from a Woodstock Institute study showing the multiplier effect of foreclosures on neighboring property values.  The impact on neighborhood values, he said, is roughly the same as for the specific home, meaning that every foreclosed home is likely to cause twice as much damage as it immediately seems, including property tax revenue losses and home value devaluations.  Rokakis pointed out that this study drew on data from neighborhoods that were relatively stable to begin with.  In cities like Cleveland, that have suffered decades of population loss and weak housing markets, he said the impacts are even more severe.

 

Anyone who lived through the FHA foreclosure waves following the Section 235 homeownership subsidy scandals has seen this movie before.  The difference today is that many of these neighborhoods have spent the intervening 35 years coming back from that wave of devastation. Thanks to irresponsible lending, outright fraud and avaricious real estate players, much of this progress is now threatened.

 

There is an urgent need to jump start programs to take control of these properties and steward them through the next five to ten years.  The earlier in the process this can be done, the more effective the intervention can be.  What are the likely ways to do this?

 

Federal action:  there are good historical models for how massive real estate dislocations can be managed.  One is the Homeownership Loan Corporation (HOLC) that was established during the New Deal to take wholesale control of the millions of foreclosed homes caused by the Depression and the liquidity crisis that nearly destroyed the banking industry.  Another is the Resolution Trust Corporation (RTC) that stepped into the S&L crisis of the late 1980's.  In both cases, government agencies swept up huge inventories of assets on which borrowers had defaulted and reorganized them in a systematic fashion.  Congress could create a similar agency today, fund it through bonds and authorize it to buy up loans and properties.  Such an agency could then act to sort through the various groups of borrowers and manage them in the most suitable ways.  To the extent that sales of these assets couldn't finance the full cost of the bonds, a likely situation, Wall St. securitizers who financed this mess could be made to pay the difference, as surviving S&L's were required to do through the Federal Home Loan Banks' RefCorp bond obligations for the RTC.  Such a solution would require swift, bipartisan support, new bonding authority, and a quick start up with a willing administration behind it.  Chances of this happening any time soon given the current situation in Washington, DC - next to none.

 

State action:  Rokakis this morning described efforts underway to create and fund a land bank in Cleveland to take possession of foreclosed properties and manage them.  He predicted that a very high percentage of the properties would eventually be demolished.  The land could later be sold for further development or to neighbors who could tend it.  What's needed for this to work is quick governmental action and lots of money.  Chances of this happening on a wide scale - moderate, and the results will be patchy as some states and localities step up and others founder.

 

Private action:  foundations, government and nonprofits could work together to create capacity to take possession of foreclosed or delinquent properties and manage them either as rentals or to re-sell them to new owners.  Given the realities of the current housing market, it's likely that many of these properties would have to be rented out in the near to medium term.  The goal would be to preserve the homes and to offer affordable housing to displaced homeowners and others who need it.  Eventually the goal would be to sell the properties to responsible owners.  There are some nonprofits that could do this now, but they would be very limited in scale.  Simply put, most housing nonprofits have developed an expertise in building and developing housing, but very few have developed expertise and capacity to acquire and manage single family homes for any length of time.  Enterprise Community Partners and some other groups have worked with HUD through its "Asset Control Area" program to buy FHA-foreclosed properties at a steep discount, repair them and then re-sell them to qualified owner occupants.  The Enterprise effort in South Central LA has been successful, but it relied on a network of real estate agents in the community to do the actual work, does not rent the homes during the interim and was not trying to sell huge numbers of homes into a falling market with newly tightened credit requirements for new borrowers. 

 

While federal action is unlikely, actions by state and local governments and community development groups like Enterprise, Neighborworks America and others can be mobilized relatively quickly.  The obstacles to success, however, are sobering and require careful review before programs are launched.

 

Property management:  very few nonprofits have significant capacity to manage rental real estate, and fewer still have it in managing scattered site, single family properties.   As one professional with experience in this noted, "sending people out to 20 properties at 3 am to check on plumbing the first time it freezes, or to repair burst pipes, is no picnic."  Mercy Housing, Inc. has a robust property management arm, but its expertise is in multifamily buildings.  It's possible that they and others with multifamily experience could be brought in to do scattered site management.  But it's not clear the capacity exists on the scale necessary in the short time frame we're facing.  There may be private management firms that could scale up quickly and do this work, but the history of such firms operating in these neighborhoods is uneven at best.

 

Program management capacity:  just as servicers are not set up to handle the huge amount of work facing them, neither are non-profits set up to handle property acquisition, management and sale on the scale likely to be necessary. If funders and government simply adopt new programs with nonprofits tasked to do this work, it had better contain millions in operating expenses to pay for the work and a flexible attitude about government contracting requirements.  If not, sensible nonprofits will demur, and the others will fail.

 

Scale:  the scope of the foreclosure wave crashing over neighborhoods is truly immense.  While it is concentrated most heavily in a few areas, it's a national problem is scale and scope.  There are no organizations today with reach into all the communities being affected to make a credible case for being able to handle the work.  Coalitions of national, state and local organizations may be able to put together a workable effort.  But it will require an extraordinary level of cooperation.

 

A New Alternative?

 

Another alternative altogether would be to create a purpose-built organization devoted solely to this problem.  It would have to be generously funded, well staffed and supported by all the national intermediaries who it would help serve and depend upon.  It would have to be able and willing to work with private sector actors like Fannie Mae, Freddie Mac, loan servicers and lenders, as well as private contractors, real estate professionals, counselors, and property managers.  Its mandate would be to acquire large numbers of properties, secure and manage them over some period of time until local markets stabilize and they can be re-sold to owner occupants.  Some of the properties should be passed to others as quickly as possible.  This could include intermediaries like Enterprise or Neighborworks, or the land bank in Cleveland, or others that could be formed for the purpose.  The advantage of having a single purpose entity to manage this is that it would enable servicers and lenders to deal with one entity in disposing of properties, enable buyers to get standard and dependable terms to take blocks of property down from the new organization, and make it possible to adopt scaled solutions across jurisdictions.  In another time Congress would create a "Neighborhood Recovery Administration" as Cal Bradford suggested this afternoon at the NTIC conference.  But that seems like a highly unlikely possibility under the current situation.  But if Fannie Mae, Freddie Mac, Countrywide and other major players wanted to, they could come up with the budget and even business planning expertise to help launch a new effort fairly quickly.

12/7/07

 

 

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Zigas and Associates can help your organization develop and launch new initiatives, strategic or business plans, and assist in designing and carrying out program and policy development efforts.  Our engagements have included the following:

 

 

• Helping the John D. and Catherine T. MacArthur Foundation develop the expansion of its multi-year, multi-million dollar Window of Opportunity initiative to preserve affordable rental housing.  We surveyed practitioners about opportunities for new grant making and investments, developed options for the Foundation's staff, and assisted in the design of a solicitation for new funding proposals.  We continue to assist in the development of this important initiative, including proposal reviews and site visits.
  
• We worked with the National Housing Trust in 2007 to develop a new strategic plan by engaging the staff, board and stakeholders in a robust examination of the market, the organization’s capabilities and resources, and refining the theory of change through which it hopes to preseve endangered affordable rental homes.  We co-planned and led a two day board retreat and subsequent board meeting at which the plan was first designed, then adopted. 
  
• We are a Senior Advisor to UniDev LLC, identifying new partners through which to expand its unique mission oriented practice of helping institutional partners create permanently affordable housing for their workforces.
  
• We are working with Corporate Social Responsibility Associates in Phoenix, AZ to help the Low Income Investment Fund to identify high potential areas to expand business opportunities.
  
• We helped Neighborworks America design and plan a highly successful national symposium on community development responses to the ongoing foreclosure crisis. 
  
• We are advising the Ford Foundation on policy and program responses to the mortgage and foreclosure crisis, working in partnership with the University of North Carolina's Center for Community Capital.

 

 

 

 

 

 

 

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• Policy advocacy, analysis and development
  

Zigas and Associates LLC helps organizations develop sound strategies, build effective leadership, and create innovation that produces results.  Zigas and Associates LLC works with both for profit and nonprofit organizations.  The firm brings to its engagements a robust understanding of organizational growth and development; a deep expertise in how policy and practice interact to create effective results; a passionate commitment to effective strategies that improve peoples’ lives; and a practical, market oriented approach to social ventures.  

Zigas and Associates LLC is led by Barry Zigas.  With more than 30 years of leadership in diverse roles in housing, community and economic development, Zigas has a unique blend of for-profit and nonprofit experience.  This includes leading organizations and workgroups ranging from more than 200 national and regional staff members as a Senior Vice President at Fannie Mae to leading the National Low Income Housing Coalition, a national nonprofit advocacy organization, with 16 staff.  He has effectively articulated and promoted innovative public policy solutions to pressing social concerns.  He helped create market-changing innovations such as the Low Income Housing Tax Credit, the HOME program, and affordable single family mortgage products that have helped to significantly expand affordable homeownership and rental housing opportunities for low and moderate income Americans.  He has led strategic planning, product development, board management and constituency relations in both the for-profit and nonprofit realms. He currently serves as Director of Housing Policy for Consumer Federation of America in addition to working with nonprofit and other clients.  He is a Trustee of Enterprise Community Partners, and serves on the boards of Mercy Housing, Inc., the National Housing Trust, the National Housing Conference, and The Avalon Theater Project.

Zigas and Associates LLC helps organizations develop sound strategies, build effective leadership, and create innovation that produces results.  Zigas and Associates LLC works with both for profit and nonprofit organizations.  The firm brings to its engagements a robust understanding of organizational growth and development; a deep expertise in how policy and practice interact to create effective results; a passionate commitment to effective strategies that improve peoples’ lives; and a practical, market oriented approach to social ventures.  Read more >>  

About Barry Zigas

With more than 30 years of leadership in diverse roles in housing, community and economic development, Barry Zigas has a unique blend of for-profit and nonprofit experience.  This includes leading organizations and workgroups ranging from more than 200 national and regional staff members as a Senior Vice President at Fannie Mae to leadership of the National Low Income Housing Coalition, with 16 staff.  He has effectively articulated and promoted innovative public policy solutions to pressing social concerns.  Read more >>