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June 22, 2011

When Congress adopted the Dodd-Frank legislation last year, it included a provision to require entities that create asset backed securities of any kind to hold at least a 5 percent interest in the securities.  This so-called “skin in the game” provision was intended to better align the interests of borrowers, loan originators, and investors by assuring that the entities putting together securities backed by mortgages and other assets have a long-term interest in the success of the underlying loans.

The task of actually defining the so-called “Qualified Residential Mortgage” (QRM) exemption was assigned to a gaggle of 6 federal regulators.  Their proposed rule was published back in April, with an initial 60 day comment period later extended until August 1, 2011.  

The QRM exemption is important for a couple of reasons.

  1. Mortgages that don’t meet the QRM requirements will cost more because of the risk retention requirement.  How great a price differential this will involve is the subject of continuing research and disagreement.  The FDIC has said, for instance, that they believe the difference will be only one-tenth of a percent, not a significant price increase.  Moody’s.com economist Mark Zandi, however, just published his own analysis of the proposed rule and estimates that the increased cost could be between  three-quarters of a percent to a full percentage point.
  2. Once the federal regulators—who include all the prudential banking regulators—adopt a standard that denotes the “safest” mortgages, it’s possible that investors and even portfolio lenders will shy away from securities backed by mortgages with lower down payments, further raising the cost and restricting access.
  3. As Congress considers further mortgage finance system reforms, the QRM standard could become an attractive “tent pole” around which to organize lending standards of an overhauled FHA and whatever successor structure is erected for Fannie Mae and Freddie Mac.

What it Does

In order to qualify for the QRM exemption, a security would have to be composed entirely of mortgages that meet the following criteria:

  • At least 20 percent down payment for purchases, 25 percent for rate and term refis, and 30 percent for a cash-out refi
  • No 60 day late payments on any credit obligations for the 2 years preceding origination, and no 30 day lates at the time of origination
  • A mortgage debt-to-income ratio of no more than 28 percent, and a total DTI of no more than 36 percent.

In addition, QRM mortgages cannot include features like teaser rates, balloon payments, interest only payment plans, or so-called Option ARM payment plans, features which played a prominent role in the housing finance bubble and crash.

The proposed regulation has generated a firestorm of protest from all points of the housing policy compass.  Consumer groups, lenders, real estate interests and others involved in the home buying process have all scored the proposal’s requirement for a 20 percent or greater down payment as unnecessarily shifting a large portion of all renters into the non-QRM mortgage space.  

With a median home price nationally of around $170,000, a 20 percent down payment would require a renter to come up with $34,000 plus closing costs.  This is a hurdle few renters without rich parents or other sources of gifts will be able to make.  The Harvard Joint Center for Housing Studies, for instance, has estimated that the median renter household has about $1,000 in cash savings, and the median minority renter household only about $500.  Even at the 75th percentile, these numbers are $5,000 and $2,500, respectively.

These points are laid out in a White Paper published by a broad coalition of groups and released on June 22, 2011.  The following Market Place Radio report gives a very brief explanation of the issues:

The statute exempted loans insured by FHA from the risk retention provisions because of their full faith and credit backing.  The proposed rule would also not apply to Fannie Mae and Freddie Mac, as long as they remain in conservatorship, because of the Treasury’s explicit backing of their obligations.  With these 3 entities responsible for 90 percent of current mortgage finance, the QRM rule is unlikely to have an immediate impact even after the current review and comment period, and the mandatory one-year gap between final rule adoption and implementation.

But as the Administration moves forward on recommendations in its February, 2011 White Paper on mortgage finance reform and tries to shrink the size of the market in which both FHA and Fannie and Freddie can operate, the QRM rules will apply to more and more mortgages.  And there will be great uncertainty about their impact for years to come until Congress resolves what to do about Fannie and Freddie and the mortgage finance system generally.

Will QRM Mitigate Risk?

Whether or not the proposed risk-retention rules will genuinely increase the quality and performance of mortgage backed securities is an underlying question.  Even at the height of the most irresponsible underwriting and loan origination, many securitizers did hold some underlying risk on the securities they created becuase they thought the risks were small and the gains would be great.  They were proved wrong when house prices started falling rather than rising, and poorly underwritten loans started failing in large numbers.  But their retention of risk was hardly an impediment to bad financial decisions and lack of attention to the underlying quality of the loans being packed for sale to investors.

The rule also has some other, more technical aspects that lenders are very concerned about; Zandi’s paper elaborates on these, as well.  And the rule would prohibit any second mortgages before or at the time of origination.  This provision will effectively halt the popular and successful state and local programs that use so-called “soft seconds” to help low wealth borrowers into their first home.  This would deal yet another blow to affordable homeownership efforts for low income and low wealth borrowers.


Foreclosure paperwork woes

September 25, 2010

Foreclosure paperwork woes

Maine Public Broadcasting did a good piece on the implications of Ally Bank’s use of a “robo-signer” to push foreclosure documents through court without carrying out the required due diligence, and quoted me.


FHFA Report

August 27, 2010

FHFA Report

FHFA, Fannie and Freddie's Conservator, yesterday released a report on the two companies that validates what many of us have been saying since mid-2008 when they melted down.

The report concludes that their failure was driven by losses in their credit guarantee book, and "Nontraditional and higher-risk mortgages concentrated in the 2006 and 2007 vintages account for a disproportionate share of credit losses." Moreover, "house price declines and prolonged economic weakness have taken a toll on the credit performance of traditional mortgages." Fully 73 percent of their capital loss was attributable to the credit guarantee business.

Since 2008, the credit quality of Fannie and Freddie's book has improved considerably, the report notes, as the new books feature "...on average, higher credit scores and lower loan-to-value ratios and include few higher-risk products."

Private label securities issuers, the report finds, were the drivers of high risk, nontraditional loans in subprime and Alt-A.  Their dominance of the market 2004-2007, and the "originate to sell" model that fed their securitization machines with increasingly toxic and unstable mortgages pushed Fannie and Freddie's market share to historically low levels.  

The report documents the sharp decline of Fannie/Freddie market share from a high of 70 percent in 2003 to 40 percent in 2006.  This loss of share and the fear of becoming "irrelevant" and missing the gravy train that was feeding Wall Street drove the companies out of their traditional comfort zone and into trying to find a role in lending with dangerous features, like interest only and low Alt-A documentation standards.  

The report also notes that crash in home prices and prolonged economic weakness also has stressed their conventional, monoline asset base.

The investment portfolio, long GSE critics' cherished whipping boy as the purported source of their systemic risk, contributed only 9 percent of their capital erosion from 2007-2010, primarily from write offs and impairments of Alt-A and subprime bonds acquired during the boom.  Freddie seems to have suffered significantly more from such losses than Fannie, with other than temporary impairments of $28 billion vs. $17 billion, respectively, according to the report.

The report documents very poor performance of loans with credit scores below 620 and downpayments less than 10 percent.  Their serious delinquency rates ranged from 8.6 percent in 4Q07 to 28 percent in 4Q09 in Fannie's book, with Freddie showing lower but still high delinquencies.  But these loans made up only 1.2 percent of Fannie's credit book in 2Q08, and 6 percent of the losses in that period.  Alt-A, by contrast, was 11 percent of Fannie's credit book but 47 percent of its losses in that period.

There are many lessons to be learned from the meltdown.  FHFA's straightforward analysis of the company's performance is welcome and helpful as debate heats up on the future design of the mortgage finance system.


Buckle Your Seat Belts

August 14, 2010

Buckle Your Seat Belts

The tenor of the coming debate over how to reorganize the mortgage finance system and the difficulties that will be faced in reaching an effective consensus is beginning to show up in the days before the Obama Administration's August 17 conference on the topic in Washington, DC.

On August 12, the National Republican Conference released a policy brief in advance of the conference in which it blames everything that went wrong in the mortgage market on Fannie Mae and Freddie Mac, and everything that went wrong with them on Democratic lawmakers or company leaders, and on affordable housing goals Congress enacted in 1993.

The statement also gratuitously recounts a discredited story that speculated that the Administration would require the GSEs to write down principal on underwater loans, ostensibly as part of an election season "gimme" to voters who owe more on their mortgages than their house is worth. The Treasury Department has categorically denied the story, and informed mortgage industry observers have deconstructed the odd mixture of rumor and speculation that generated it, but the Conference's brief nevertheless resurrects it in order to criticize it.

The brief provides only a summary of the Conference's policy recommendations, which they summarize as follows:

Taxpayer Protection: The Republican GSE reform plan would put an end to the taxpayer bailouts for Fannie Mae and Freddie Mac. Fannie's and Freddie's current government-subsidized structure will cost taxpayers hundreds of billions of dollars. The Republican plan would end the model that allows privatized profits and socialized losses by phasing out the GSE charter. Once the charter ends, Fannie and Freddie would be required to conduct all new operations as fully private sector companies competing on a level playing field.

Restoring Market Discipline: The plan would repeal the GSEs' exemption from paying state and local taxes and repeal the exemption allowing GSE securities to avoid full registration with the Securities and Exchange Commission. The plan would also end the current GSE conservatorship by a date certain and place Fannie and Freddie in receivership if they are not financially viable at that time. If they are viable, the plan would initiate the process of transitioning Fannie and Freddie into fully private entities. Lastly, the plan would provide for the orderly wind down of the GSEs' existing business commitments, following the model successfully used in transitioning Sallie Mae from a GSE to a private company.

Encourage Innovation and Choices for Consumers: Fannie and Freddie have monopolized mortgage finance and used their government privileges to crowd out competition, stifling innovation and increasing systemic risk. Consumers benefit from competition as a result of innovation and lower costs. The Republican plan would put an end to Fannie's and Freddie's monopoly and force them to compete fairly in the financial marketplace.

How mortgages would be financed in the future, how consumers would be assured access to long term, fixed rate financing, and what would happen to the $5 trillion in outstanding MBS guaranteed by the companies and currently backstopped by the US Government is not explained.

If the debate about mortgage finance's future cannot be raised above the level of a partisan turkey shoot, the prospects for any meaningful change are likely to be dim.

Controversy Over the Dividend

Also this week, the National Association of Realtors© sent Treasury Secretary Timothy Geithner a letter urging him to reduce the current 10 percent compounding dividend on the money provided to shore up the companies.

The letter states that,

This dividend is twice the amount charged to banks that received assistance under the Troubled Asset Relief Program (TARP) and more than other firms have been required to pay in exchange for federal support. The Treasury- GSE contract imposes what we think is a punitive dividend that works as an unnecessary drag on the housing and economic recovery. The required dividend should be significantly reduced for a number of reasons.

The letter makes three further points about the dividend. First, the burden of paying is a factor driving the companies to raise fees and make mortgages more expensive as they try to rebuild a profitable business model. Recent reports that Fannie Mae's new book of business is "pristine," the letter notes, means it has gone too far in tightening the credit screws.

Second, reducing the dividend will simplify any transition plan for the companies as the mortgage finance sector's future is designed by reducing the ultimate cost of repaying the contributions.

Third, the letter notes that "it makes no apparent sense for the Treasury Department to transfer amounts to the GSEs so they will have enough money to pay the dividend back to Treasury." Both Fannie and Freddie's most recent quarterly reports stated that payment of the dividend will become a larger driver of future requests for capital as the dividend repayments are outstripping profit levels in any recent years before the crash.

The letter suggests reducing the dividend to either the Treasury cost of borrowing or the GSEs' cost of borrowing given the Treasury backstop guarantee.

Guest List

Finally, the Administration's invitation list to the August 17 conference has stirred its own controversy. The list is not public, and no small amount of time in the last few weeks has been spent trying to find out "who's in, who's not." (I was invited and will be attending.)

The issue of the list broke into the news Thursday with a story in the Washington Post quoting National Community Reinvestment Coalition President John E. Taylor criticizing the line-up of panelists at the conference, followed by a posting on Salon and the American Prospect's blog, TAPPED.

The stories focused on the list of participants in the plenary session panels that will kick off the scheduled four and one-half hour conference. Because the list of those invited to participate in the plenaries and six subsequent smaller break outs on specific topics is not public, the relative mix of consumer advocates, industry representatives and others is hard to know. But the history of the Administration's outreach to consumer groups on this and other pertinent housing finance issues generally has been good. It will be interesting to show up next Tuesday and see who's actually in the crowd and which groups were asked to attend.


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