Fannie-Freddie Overhaul

Posted by kevin on April 15, 2014 under Foreclosure Blog | Comments are off for this article

Since the federal bailout of Fannie Mae and Freddie Mac (the GSE’s) in 2008, there has been a call for their overhaul. The question is, what is a suitable replacement?

Yesterday, there was an article by Ken Blackwell, former undersecretary of HUD and mayor of Cincinnati (how many n’s, how many t’s) and now a director at the Coalition for Mortgage Security. The stated purpose of the Coalition is to educate the public concerning housing policy and finance. The article says that the coalition wants to preserve the 30 year fixed rate mortgage.

In this article, Blackwell states that there is broad consensus in Washington that the GSE’s should be replaced by a private mortgage secondary market funded by private capital with a limited government role.

Blackwell has a bone to pick with the feds. He points out when the federal government bailed out Fannie and Freddie, it took 80% ownership interest. Now that the government has been paid back, it is claiming still 80% ownership but 100% of the profits of the GSE’s. In effect, the feds have screwed the shareholders of the GSE’s. By creating and maintaining such a policy, Blackwell claims that investors will be very reluctant to jump into any new private mortgage financing vehicle.

Implicit in the article, however, is that the Coalition fully expects the government to be there in case of future meltdown. So, the private market is not really a private market.

Yesterday, the WSJ ran an editorial relating to the reform of Fannie and Freddie. It discussed in some detail the Johnson/Crapo bill which would replace the GSE’s with multiple private mortgage bond issurers that would each have a taxpayer guarantees. To get those guarantees, the issurers would need to maintain (over time) a 10% capital level vis-a-vis aggregate mortgage loans.

The editorial rails on against provisions in the bill which encourage and subsidize loans to people who are not creditworthy. On the other end of the spectrum, the editorial states that while the median price for a home in the US was $189,000, a borrower could borrow as much as $625,000 and have that loan backed up by the feds. WSJ questions whether the government should be subsidizing the somewhat wealthy on their home purchases.

From my viewpoint, it appears that the politicians want to get rid of Fannie and Freddie while at the same time keeping Fannie and Freddie. Different groups want to dump the aspects of the programs they do not like, and keep the one’s they do like. Seems like a lot a work to end up pretty much at the same place.

Why the Housing Crisis?

Posted by kevin on September 18, 2013 under Foreclosure Blog | Comments are off for this article

If you listen to the various commentators, there were numerous reasons for the housing bubble. Some blame the government. the Community Reinvestment Act, enacted during the Carter administration, encouraged (or better yet, demanded) that banks lend money to people who would not traditionally qualify for a mortgage loan. That law basically lay dormant during Reagan and Bush I. However, as the economy picked up in the second Clinton administration, the feds started to push this law.

Going hand in hand with the Community Reinvestment Act was the Federal Housing Enterprises Financial Safety and Soundness Act (which was eventually anything but), a 1992 Act which gave HUD authority to administer GSE’s (Fannie Mae and Freddie Mac) affordable housing provisions. The law established a quota of loans to borrowers who were at or below median income in their area and required to be bought by the GSE’s. These loans were commonly called sub-prime mortgages. The initial quota was 30%. By 2008, however, the percent of subprimes on the books of the GSE’s was over 70% of all subprime loans.

Others blame Wall St and how it is structured. Prior to the 1980’s, investment houses were mostly partnerships with unlimited liability. One reckless partner could bring down the whole firm, so risk was managed by the partners keeping an eye on each other. But Wall St realized that it needed more capital than its partners could generate to be involved in bigger trades, bigger deals. It needed OPM- other people’s money. To accomplish this, the firms became corporations, went public and brought in piles of money. The new owners were the shareholders. The old owners had shares and managed the firm. The money that the old owners took out changed from profits to yearly compensation. Pay was tied into performance. Bigger profits, bigger pay and bonuses. However, with bigger profit comes bigger risk. In the past, the unlimited liability aspect of the partnerships checked risk. But now the investment firms were corporations dealing with OPM, so risk was no longer a primary factor. The investments firms borrowed heavily to make the big deal or trade. That’s fine as long as everything is going up, but a disaster when the bottom falls out.

A third factor was, related to the structure of Wall Street but accomplished by the government, was the repeal of the Glass Steagall Act. This Act came about in the 1930’s. It separated commercial banking from investment banking. Restrictions were put on commercial banks because they were take deposits from the public. That gave them lots of capital but restricted what they could do with it. Investment banks could not take deposits; and therefore, had less capital. However, investments banks could get involved in more and riskier deals or trades for their own account. By the 1990’s, commercial banks were looking at the investment banks and saying, ‘imagine what we could do with all out money if we had the investing flexibility of the investment banks’. Investment banks were looking at the commercial banks and saying,’ if we only had the capital that commercial banks have, imagine what we could do’. The solution? Get rid of Glass Steagall. We all know that Democrats and Republican agree on very little. But they had no trouble, during the second term of Clinton, coming together to repeal Glass Steagall. 90 Senators voted for the repeal. Do I hear, Campaign Contributions?

Finally, on the private sector side, was the emergence of private mortgage securitizations. In short, Wall St bundled a thousand or so mortgages and put them into a trust. Certificates of participation in the trust were sold to investors. Bad loans were mixed with pretty good loans and good loans, but somehow the trusts all got triple A ratings- even if they were dogs. Wall St used its massive marketing apparatus to sell these securitizations around the world. Hell, you got 50-100 basis points better than Treasuries on an investment that was triple A. Investors fell for it. The big wigs at the investments houses saw the incredible profits coming out of these securitizations and push for more.

Now, just so that political blame can be shared, the Bush II administration had to see the warning signs of a housing bubble but took no aggressive steps to stop it. Yes, they half-heartedly tried to rein in the GSE’s but backed off when certain congress people started to scream that lower income people were being hurt.

Well, in late 2007, the bubble burst. Rates on adjustable mortgages spiked up. People could not afford to pay and went into foreclosure. This led to a drop in housing prices. Then, more people faced foreclosure. They could not refinance because the value of their homes now did not justify a re-finance. So, they went under. Prices continued to fall. Investors then refused to invest in private securitizations. This eventually lead to the bailout of Bear Stearns followed by the bankruptcy of Lehman Bros, and then the financial crisis and recession.

As I said before, there is enough blame to go around; however, my assessment is that government policy was the dominant factor in this whole mess- not say 90%, but at least 60%.

Keep an eye on what the government does now that Fannie and Freddie are making money again. Any shift in policy to make loans more available may be the first step toward the next bubble.