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.

Kicking Assets

August 19, 2011

The government last week launched a new “Request for Information (RFI)”  asking for suggestions about how to take Fannie Mae’s, Freddie Mac’s and FHA’s inventory of foreclosed homes and move it in bulk into the hands of private investors so they can convert them to rental units.

The solicitation states that it is seeking

“ideas for sales, joint ventures, or other strategies to augment and enhance Real Estate-Owned (REO) asset disposition programs of Fannie Mae and Freddie Mac (the Enterprises) and the Federal Housing Administration (FHA).... A specific goal is to solicit ideas from market participants that would maximize the economic value that may arise from pooling the single-family REO properties in specified geographic areas.”

I’m glad the Administration has reawakened its interest in the housing markets after two years of the weak showing of its flagship “Making Home Affordable” mortgage modification program.  Maybe the solicitation will generate proposals to optimize the GSEs’ management of their REO and use existing public investments in the firms to achieve long-term public benefits.  But it’s much more likely to elicit offers from private equity to buy properties in bulk at a steep discount to convert to rentals and ultimate resale. If this is the case, it seems to me the Administration would be deliberately throwing away an opportunity to turn the GSE lemons into at least a weak lemonade and missing the chance to use its stranglehold on Fannie Mae and Freddie Mac to do something useful.

What It Says

The RFI lists the following key objectives:

• reduce the REO portfolios of the Enterprises and FHA in a cost-effective manner; • reduce average loan loss severities to the Enterprises and FHA relative to individual distressed property sales; • address property repair and rehabilitation needs; • respond to economic and real estate conditions in specific geographies; • assist in neighborhood and home price stabilization efforts; and • suggest analytic approaches to determine the appropriate disposition strategy for individual properties, whether sale, rental, or, in certain instances, demolition. FHFA, Treasury and HUD anticipate respondents may best address these objectives through REO to rental structures, but respondents are encouraged to propose strategies they believe best accomplish the RFI’s objectives. Proposed strategies, transactions, and venture structures may also include: • programs for previous homeowners to rent properties or for current renters to become owners (“lease-to-own”); • strategies through which REO assets could be used to support markets with a strong demand for rental units and a substantial volume of REO; • a mechanism for private owners of REO inventory to eventually participate in the transactions; and • support for affordable housing.

Equity funds that have been busily raising capital in anticipation of swooping in on distressed assets have an obvious reason to want the government to give them Fannie’s and Freddie’s homes on the best terms. They’re hoping for a windfall when markets come back and these homes could be sold once more for a profit.  Renting them in the meantime while values and demand remain depressed would be a good strategy in many markets, although the challenges of adequately managing scattered, single family rental units is no small thing.  It would reduce vacancies and expand the supply of rentals at a time when they’re badly needed.  And real estate interests, state and local governments and communities themselves are terrified by the looming flood of foreclosed homes that is building up and depressing home sales and prices.  They likely would welcome any moves that would slow down the torrent.

But why should the government be so anxious to engineer the transfer of thousands of properties into private hands, when it could hold them itself through the GSEs, offer them for long-term rentals, protect communities from opportunists and profiteers, and keep that potential upside for itself?

America’s Best Landlords?

The problem with turning to the private sector to move these properties out of the GSEs’ hands is that these interests ultimately will want to generate sufficient profits to give their investors competitive returns.  This will mean one or a combination of outcomes:

• Once acquired, maintenance and upkeep on the properties will be held to a bare minimum to maximize the rate of return on rental income.  See “Slumlords, neighborhood deterioration” for further details. • Homes will be flipped as soon as possible to new investors who couldn’t bid for large numbers of units.  See above or below, repeat. • Investors offer smaller lots of homes to state or local governments, at a mark-up that secures their return, hiking the ultimate cost of the homes. • Homes are maintained and held until the market firms up, rents are set at the highest level possible, then the homes flipped to new owner-occupants, who will have to pay a high enough premium to generate equity-like returns for the investors.

A recent news story on mortgage fraud noted that “Fannie Mae continues to investigate REO flipping involving real estate agents who withhold competitive offers on REO properties so that they can control the acquisition and subsequent flip.”  In other words, private sector real estate interests already have found ways to scam the REO disposition process to enrich themselves.  Freddie Mac published an article on its Executives Perspectives Blog outlining its increased attention to fraud by real estate professionals in arranging short sales.

Fannie and Freddie are effectively owned by the US government.  They no longer have to worry about shareholders’ interests, or Wall Street’s assessment of the net profit potential of their programs.  In another time, progressives might have lobbied for the government to set up a dedicated entity to facilitate the clearance of excess real estate inventory and do the utmost possible to protect current homeowners and local markets.  But the government already has this solution to hand in Fannie Mae and Freddie Mac.  So why not use them for this purpose?

This would keep the properties occupied and generate some revenue.  This could be used to offset what they paid to redeem the mortgages from investors, and cover ongoing maintenance and management costs.  As markets stabilize, properties could be put into the for-sale market at a controlled pace with an absolute preference for new owner-occupant buyers, in many cases even the families then renting the homes.  Unlike private investors motivated by the need to generate the highest possible short-term return on investment, this approach would allow for more patient management of the rental assets and a focus on the social and community returns, as well as the financial ones.

It’s the Politics, Stupid

Nothing illustrates the quandary of Fannie and Freddie’s conservatorship more starkly than this paradox.  Politics in Washington means that the GSEs can’t be allowed to enter into any projects that could extend their lifetimes any longer than minimally necessary.  So there is a premium on solutions to the REO dilemma that move the assets off their books as quickly as possible.  Even if that means relinquishing the positive role that government could play by leveraging its patient capital to directly manage these assets in more creative and responsible ways.

Some respondents to the RFI may propose making better use of the GSEs themselves through direct management of the assets, or through some joint venture that would keep the assets at least nominally under public oversight.  But I suspect that most of them will focus on how to move the assets into private hands with the lowest cost and fewest strings.

Realistically, no matter what Congress decides to do with Fannie and Freddie over the next few years, there are going to be long-term legacy resolution issues like the REO problem that will have to be managed.  The government could reimagine conservatorship as a means to broker long-term stability in distressed markets by using taxpayers’ investments in the GSEs as patient capital deployed for public purposes rather than merely as a “bail out” to be unwound as quickly as possible.  Nothing would stop Congress from developing a new, long-term mortgage finance structure and barring Fannie and Freddie from doing any new business after a date certain.  But that need not preclude the continuing management of the legacy book, and particularly the troubled book and REO, by the companies through an extended conservatorship or through some other reorganization focused on the orderly unwinding of their assets and obligations.

It seems to me that the constraint is not economic or managerial.  It’s political.  In the current climate, that may be all it takes to see the government give up one more opportunity to do the obvious in favor of the short-term and potentially much more costly option of privatization.


MN Public Radio on foreclosures

July 12, 2011

UMinn law professor and former MN Assistant Attorney General and I discuss foreclosures in this call-in radio program.



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.


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