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It Ain’t Necessarily So

August 03, 2009

In a recent Washington Post interview, Freddie Mac Chairman John Koskinen regrettably implied that the affordable housing goals that Fannie Mae and Freddie Mac were required by HUD to meet were a cause of the two companies’ financial troubles.  Responding to a question about how a revised model for the secondary market might better balance public purpose mission goals with duties to shareholders, Koskinen replied,

I’ve never thought that those were inconsistent goals or impossible to manage. The problem in the past was the increased requests for expanded affordable housing were made by the administration. No one ever balanced out exactly what that was going to cost.

One of the most significant things that’s happened is the setting of the affordable housing goals has now been moved to our regulator. So the regulator responsible for looking at safety and soundness is also the one looking at setting the housing goals, and therefore will be able to look at what the costs and risks are of expanding support for affordable home ownership in the context of running a for-profit corporation.

I agree that combining mission and safety and soundness regulation in one place is an improvement over the two regulator model that started in 1992.  And I agree that HUD set the goals in 2004 at unrealistically high levels.  But the implication that meeting them required jeopardizing the company’s safety and soundness is hooey.  If anything, the record shows that both companies succumbed to market pressures and fears of becoming irrelevant as unregulated mortgage lending surged in the mid-2000’s and sacrificed their most important mission imperatives in the market scramble that followed.

Freddie Mac especially did pursue a strategy of buying subprime mortgage bonds as a significant contributor to meeting its housing goals performance.  And it’s true that these bonds have cratered in value, causing some of the company’s losses.  But that was a business choice that Freddie Mac made in deciding how to fulfill the housing goals madate.  HUD’s report on the GSEs’ housing goals performance in 2004-2005 concludes that while no more than 72 percent of Freddie’s low mod home purchase loans were from “traditional sources” during those years, more than 90 percent of Fannie Mae’s were.  Freddie’s subprime bond purchases had much higher percentages of goals qualifying home purchase loans than their purchases from traditional sources (60.8 percent low mod in the securities vs. 40 percent in their traditional business.) This may have exacerbated their financial peril.  But they did not have to invest heavily in bonds backed by loans focused on weak credit borrowers, as Fannie’s alternative strategy shows.  Moreover, any analysis of the two companies’ financial reports since they melted down shows clearly that the immense portfolios of Alt-A loans they acquired from 2006 until the market imploded in 2008 have been the big drivers of their credit losses.  I analyzed these numbers in an earlier blog.  They haven’t changed significantly since then.

These Alt-A loans were typically made to borrowers with very good credit ratings and relatively high down payments.  They were not tailored to low mod borrowers, or to underserved communities.  Sometimes they met those goals, but on the whole they were not positive contributors to the GSEs’ housing goals scores.

Both companies pursued these risky and ultimately costly loans because they were afraid of giving up market share and profits.  They were both late to the market, and once in, stayed too long.  They wound up with big investments in loans that were the first to fail, and failed with bigger losses than their traditional books of business.  When loans that make up only about 10-15 percent of your total credit exposure account for nearly 50 percent of your credit losses, something is very, very wrong.

This isn’t just my view.  James B. Lockhart, Director of the Federal Housing Finance Agency (FHFA) said as much in a major speech last week at the National Press Club.

Neither Fannie, Freddie, nor FHFA has published any useful data about the performance of the loans that met their housing goals.  They also have not provided any useful information on the performance of their specialized loan products like My Community Mortgage ©, Community Home Buyers©, or Affordable Gold© that offered flexibilities to borrowers that met HUD’s housing goals.  Thus, it’s not possible to compare their performance with Alt-A or other loans.  Given the collapse in home prices across the country, the lower down payments and credit quality requirements of these products, they likely are suffering higher loss incidences than in the past.  With relatively smaller loan balances, they also likely are suffering lower loss severities than Alt-A loans that were more concentrated in high cost areas.  Evidence from the small sample of loans analyzed by UNC’s Center for Community Capital of the Community Advantage© loans packaged by Self Help for Fannie Mae suggests these specialized loans to goals-qualifying borrowers are not driving Fannie Mae’s losses, although they undoubtedly are contributing to them.

The deeper failure by both companies was their substitution of a broad view of their mission to provide stability in the marketplace for a narrow view that their mission obligations started and ended with meeting the housing goals.  They should have run their businesses from the foundational assumption that they were chartered to provide a more fundamental and long-view role in the market than the latter day buccanners from Wall Street who flooded the market with high risk mortgages.  Instead, they saw them as their direct competitors and tried to “bring it to them” by conmpeting for loans that were way outside of their own sweet spot.  This short term focus on market share and profits led them far astray from their core business and they—and taxpayers—are paying the price for that error.

Both Fannie Mae and Freddie Mac had multiple levers they could use to assure that their businesses produced results consistent with the mandated housing goals. In 2006, Fannie Mae did modify its automated underwriting engine to secure loans with overall weaker profiles, and this did boost its success in acquiring goals qualifying loans.  This probably has led to higher losses in these loans.  But in addition, after 2004, both could have chosen to moderate their financing of loans that were newly accessible through higher loan limits, for instance.  These higher balance loans seldom met any of the housing goals, and provided liquidity in markets where there was little evidence it was needed.  Similarly, a less aggressive push to compete with Wall Street firms by vacuuming up Alt-A loans at the top of the market would have helped both of them reach the HUD goals more easily and kept them truer to their chartered purpose.  But neither was willing to temper their overall business to meet the housing goals.  Instead, they chose to chase market share and revenue in competition with private label securitizers, who by then were neck deep in dangerous, unstable loans.

Koskinen may be right about the housing goals costing too much and contributing to Freddie Mac’s failure.  But he owes the public, Congress and his regulator a much better explanation of why this is so than has been offered so far.


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