Please read and comment on the entries that follow.  The most current one will be highlighted on this page; earlier entries can be found under the archives link below.

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.



October 12, 2008

Evelyn Mulwray

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."


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, sportsscience 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.


Game Over?

October 09, 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.


  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.


  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.

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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