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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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White House Statement on Financial Reform

July 27, 2010

The Administration today (July 27, 2010) announced the next step in its process of soliciting public input on the future of the housing finance system, the first of an apparent planned series of conferences.  This one will be held in Washington, DC, on August 17.  Never mind this is smack in the middle of peoples' vacations; the convening by HUD Secretary Shaun S. Donovan and Treasury Secretary Timothy Geithner should draw a full house.

Treasury Under Secretary for Domestic Finance Jeffrey A. Goldstein also put up a post on the White House blog today outlining the Administration's steps to support the housing sector, and the principles that are guiding its work.  I am particularly pleased at this post because it echoes themes that I have been pushing with the Administration and others.  

In March I circulated a White Paper that I produced for CFA with support from the Ford Foundation.  Last week I submitted a lengthy response to the Administration's solicitation for input on the future of the housing finance system.  Some of the key points I made in both are echoed in Goldstein's post.

Whether that had anything to do with its tone or not, it's nice to see they are tracking many of the same points that I am.  Hopefully this augers well for the process.

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Buyer, Beware?

July 27, 2010

Mortgage fraud and misrepresentation is taking center stage in the clean up of the mortgage mess.

Fannie Mae and Freddie Mac have been pushing back record numbers of loans to their customers after reviews turned up irregularities and failures to follow underwriting guidelines.  In an effort to help the GSEs recover funds from lenders who bent the rules, their Conservator, theFederal Housing Finance Agency (FHFA) has sent subpoenas to more than 60 lenders demanding documents that the GSEs need to make their case. In a recent NY Times article, Gretchen Morgenstern summarizes the questionable behavior of securities issuers in passing on poor loans to investors, even when they knew the loans didn’t meet investor expectations or advertised quality.

I was asked recently by someone looking into the crisis if I could quantify the varying degrees of culpability for fraud among buyers and sellers.  I can’t.  I do believe there are borrowers out there who knowingly fudged their own numbers to qualify for a loan.  Investors, especially, had plenty of incentive to bend the truth to get the money to buy the property they planned to flip.  

But I believe far more damage was done by creditors and sellers of loans. As house prices rose, the pool of eligible borrowers shrank.  Yet tons of capital was competing for mortgage backed assets.  This combination provided plenty of incentive for the systematic weakening of underwriting and ultimately the faking of underwriting to keep the fees coming. The originate-to-sell model that had everyone passing the risk up the line while taking a cut fostered an environment that discounted loan quality to boost loan quantity.  And the further up the chain these loans went, the less incentive there was to look too closely.

We know that there were investors who saw behind the curtain and called out the weak standards.  Michael Lewis’ The Big Short is a marvelous narrative about just these folks.  And as the NY Times piece points out, many of those packaging and selling faulty loans knew too, they just didn’t care.

The recently passed financial reform bill contains some important new restrictions that should put the lid on this for the near future.  But what ultimately is emerging from this wreckage is a story mostly about bent sellers and middlemen.

Buyer, beware, indeed.

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Homeownership: Still the American Dream?

June 12, 2010

Joe Nocera in today’s NYTimes has a thoughtful piece on homeownership and the role of mortgage financing, and Fannie Mae and Freddie Mac in particular, in the mortgage meltdown.   He cites a recent speech by FDIC Chair Sheila Bair in which she concludes that the federal policy preoccupation with homeownership went too far, helped fuel the bubble and led too many people into homes they could not afford.  He summarizes the wide variety of programs—some, like the mortgage interest deduction—and concludes that not only did these policies propel rising homeownership rates in both Republican and Democratic Administrations, but also abetted the rise of subprime lenders. 

Interestingly, Nocera rejects the arguments of conservatives—and long-time opponents of the GSEs—like Peter Wallison at AEI that the housing goals imposed on Fannie and Freddie are a leading cause of the crisis.  

Indeed, conservatives tend to view the affordable housing goals imposed on Fannie and Freddie as the central reason for the credit crisis. “In order to increase homeownership, Fannie and Freddie were required to decrease their standards,” said Peter Wallison, a fellow at the American Enterprise Institute and perhaps the country’s leading critic of the G.S.E.‘s. “We made a big mistake in trying to force housing onto a population that couldn’t afford housing.”

But, to my mind, that view is only half-right. Yes, people got loans who had no hope of paying them back, and that was insane. But Fannie and Freddie’s affordable housing goals - which the G.S.E.‘s easily gamed - were not the main reason. Rather, it was the rise of the subprime lenders - and their ability to get even their worst loans securitized by Wall Street -that was the main culprit. Fannie and Freddie lowered their standards mostly because they were losing market share to the subprime originators.

Did government policy make the rise of the subprime lenders possible? You betcha. Over time, the federal government gradually loosened regulations and interest rate caps that allowed the business to first become viable and then to explode. And it completely bought into the idea that the subprime industry was a force for good, because it was expanding homeownership. This, of course, is something the mortgage originators encouraged.Angelo Mozilo, the founder of Countrywide Financial, was as vocal about his company making the American Dream possible as any Fannie Mae lobbyist.

Nocera goes on to point out the aggressive and sometimes abusive practices employed by the subprime lending industry to generate the leads and loan originations that fueled their fee-driven culture.

Gary Rivlin, my former colleague at The New York Times, has just published a scathing, important book, “Broke, USA,” which includes one shocking anecdote after another of people being conned into taking on mortgages, filled with hidden fees and adjustable rates, that they couldn’t possibly afford. The companies that did these things were not the outliers - they were the bulwarks of the industry: Household, Countrywide, New Century and a raft of others. And when state officials tried to crack down on these unseemly practices, the Office of the Comptroller of the Currency, instead of investigating, blocked their efforts. After all, homeownership was on the rise!

It’s refreshing to see someone like Nocera cut through all the partisan and ideological yadda-yadda that has dominated discussions about Fannie and Freddie.  There’s no doubt they screwed up.  But their final, fatal flaw wasn’t trying too hard to meet the housing goals imposed by Congress.  It was in mistaking themselves for Wall Street investment firms rather than specially chartered entities with a mission to provide stable, safe financing for everyday folks.

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NHC Housing Video

June 11, 2010

To mark this week’s annual Housing Person of the Year gala, the National Housing Conferencecommissioned a video to highlight and celebrate the many innovative partners working hard every day to provide decent, affordable housing for low and moderate income families.  You can see the video here, and

please check out the link to their website for more information about the work that NHC and its partners are doing.

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