There’s ongoing talk on Capitol Hill about housing finance reform, and what to do with the Government Sponsored Enterprises (GSE’s) Fannie Mae and Freddie Mac, who fell into conservatorship during the mortgage market meltdown five years ago. The goal is to prevent a similar crisis from occurring again.
The GSEs are on better footing now. They will have repaid everything they “borrowed” in their bailouts, and are positioned to have significant profits in 2014 (they combined for $129 billion in profits in 2013, for comparison Apple’s annual profits are roughly $37 billion) all of which will be siphoned directly to the US Treasury, vs. shareholders, due to their conservatorship agreement, which was revised last year and facing a law suit from shareholders.
As a result, will there even be enough momentum left to actually change the GSE’s structure and create any real housing finance reform? Just because they’re back to profitability now, doesn’t mean that will be sustainable, and… any losses would again hit American taxpayers, unless the companies are restructured or wound down. It’s going to be interesting to watch.
The United States is really the only country in the world that offers, and relies so heavily upon the 30 year fixed mortgage, as a pillar of its housing industry, and homeownership ethos.
Yet, I was surprised to learn, on a list of 42 OECD (Organization for Economic Cooperation and Development) member countries, plus Singapore, the US ranks 34th with a 65% homeownership rate (Drew DeSilver, Pew Research Center, Aug. 6, 2013). That’s above France, and Japan, but below Canada, Mexico, the UK, Italy and dozens of other European countries, of which Romania has the highest homeownership rate, at 96%.
What’s interesting is that, for the most part, the US took the brunt of the force of the mortgage market meltdown in terms of foreclosure rates, and resulting declines in home values, compared to other countries around the globe.
The economic crises in other countries were less about foreclosure rates and home values declining, and more due to a liquidity crunch, as everyone tried to find out who held what portion of mortgage backed securities issued from the US, and where the shoe was going to drop next (along with some other structural problems within the EU). Certainly, that chain of leverage was a big part of the problem in the US, too, but our foreclosure rates and home value declines were much more severe than other countries.
Why is that, and what are we supposed to do to not repeat the same mistake in the future?
Most people agree that:
• We don’t want to put our housing market through another crash like that again.
• We don’t want to have taxpayers on the hook for massive losses and bailouts if there is another crash
• We want lenders who intentionally underwrite loans with looser credit standards to carry those increased risks
• We want borrowers to understand the loans they’re buying, and to take loans they can afford to repay
• In short, we want a robust and well-functioning housing market, with reasonable interest rates affording people the American Dream of homeownership, but without it going too far again.
Maybe. Maybe not so much.
There are currently two competing pieces of legislation moving through each house of Congress. The House of Representatives’ Financial Services Committee, chaired by Jeb Hensarling of Texas, is promulgating the PATH (Protecting American Taxpayers and Homeowners) Act. Over in the Senate, the proposed legislation w/ the most traction is the Warner-Corker Housing Finance Reform and Taxpayer Protection Act.
There are some similarities to the legislation and some stark contrasts.
Both proposals look to wind down Fannie Mae and Freddie Mac within a 5-year period of becoming law. Both programs look to protect taxpayers by shifting the risk of originating and securitizing mortgages away from the government onto those originating and securitizing them. Both purport to save the availability of the 30-year fixed rate mortgage. Both programs still rely on mortgage backed securities, possibly with an increasing role for covered bonds. They both look to revise or repeal the Affordable Housing targets that are current policy.
Where things begin to differ is that the PATH Act looks to almost completely privatize the mortgage market, leaving only a small footprint for the FHA, VA and USDA to operate, and service low- to moderate-income homebuyers, first time buyers, veterans and active military and Rural Development Program loans, respectively.
Proponents of the PATH Act point to the Jumbo mortgage market, which has never had a government guarantee, as the pinnacle of housing finance responsibility and effectiveness. They point out that the gap between jumbo loan rates and conforming loan rates (the market in which Fannie Mae and Freddie Mac currently dominate) has averaged about .25% to .5%, hardly enough to stifle wide spread use of a private mortgage market.
What they don’t point out is that in Jumbo financing, you typically must have 20% down for a purchase, or 20% equity to refinance loan, in addition to a high fico and generally stringent income and asset requirements. And, for most lenders, if they’re financing over $1 million, then they want 25% down or more. Jumbo lenders are also making a habit of targeting those borrowers’ investment portfolios, and transactional business (many jumbo borrowers run their own companies) so they can leverage layers of relationships with that segment of the population.
The “conforming loan” borrower generally offers fewer profit center opportunities for lenders to tap.
Supporters of the PATH Act also point to the fact that the GSEs really never held or insured the lion’s share of mortgage backed securities anyway. They show that only once, in 2003, did Fannie Mae and Freddie Mac’s MBS issuance and portfolio holdings reach as high as 50% of all MBS issues (Dwight Jaffee, Booth Professor of Banking, Finance and Real Estate, Haas School of Business, UC Berkeley before the Committee on Financial Services of the House of Representatives, June 12, 2013). So, removing them from the marketplace shouldn’t have any significant adverse impact on the market’s ability to operate smoothly.
Taking a more centrist approach, the Corker-Warner bill would aim to shift most of the mortgage market to private entities, requiring the originating lenders and those packaging the securities to keep some skin in the game (a 10% first loss provision) and establish a Mortgage Market Utility to act as a guarantor of last resort, in the event of another market meltdown.
They want the Mortgage Utility to act as a backstop – even if at a marginal level – so that if there is another crisis, there’s an entity with the staffing, contacts, systems and bandwidth to step in and act swiftly, if needed. Without such a mechanism, they argue, in the event of another similar crisis, the mortgage market would grind to a halt, exacerbating the meltdown.
Proponents of the Corker-Warner plan claim that the government guarantee facilitates the availability of 30 year fixed mortgages, because they provide some hedge against risk of lending long for banks, and those holding the underlying securities.
An interesting component that neither proposal addresses is the lack of recourse financing in the United States.
According to a thesis by Ryan Kreitzer for the Leonard N Stern School of Business at New York University, May 2012, most other nations’ real estate loans have full recourse provisions. That means that lenders and/or bondholders can pursue borrowers who default until they’re made whole, whether by sale of the asset, pursing other personal assets, or even pursuit of future wages.
No doubt, borrower recourse would be a contentious issue, but does that mean it shouldn’t be part of the conversation?
If the idea is to make sure that everyone within the real estate financing process is keeping a level head (ie: banks lending to people who can repay them, and that borrowers understand what they’re borrowing) doesn’t it also make sense to ensure that borrowers truly weigh the risks and rewards of their financing? If borrowers knew they were at risk in the event of default, they may be less likely to take on debts they don’t think they can afford, even during a period of “irrational exuberance”. Loose underwriting standards were not the entire reason for the run up in home prices, and their subsequent crash.
For those who say that recourse financing will prevent people from taking the steps towards homeownership, why then do so many countries with recourse financing have higher homeownership rates than the US?
If you look across the list of OECD nations, most of which have higher homeownership rates than the US, there are only a few that have explicit government roles in their housing finance markets including Canada, the UK, and the US. It can be argued that the EU has implied guarantees, because of their system of covered bonds. But regardless of those countries governments’ involvement in their housing markets, the vast majority have recourse financing, and their housing markets didn’t go through quite the yoyo ride we’ve seen here in the US.
We cannot legislate ourselves into a perfectly operating mortgage market devoid of risk. Nor can we rely on market dynamics to create a system offering the level of access we like, without opportunities for abuse. But I think we’ve seen some of what works, and what doesn’t over the last 80 or so years.
If cooler heads prevail, we may actually end up with a more stable, and smoothly operating housing market than what we’ve ever had. On the other hand, if they get it wrong, maybe they’ll find that the market place really isn’t interested in offering 30yr fixed rate mortgages for the masses, without some form of government involvement.
Time will tell. I’ll try to keep you posted if anything interesting happens to Fannie and Freddie that would vastly reshape our mortgage markets.
In the meantime, here are your rates for this week. Please don’t hesitate to call or email if you, your friends, or family have questions about financing residential or commercial real estate.
|30 yr fixed mortgage
|15 yr fixed mortgage
|Jumbo (ask me about Super Conforming limit, per your zip code)
|30 yr fixed mortgage
|15 yr fixed mortgage
|Rates subject to change without notice.
|Please keep in mind, these rates and statistics are for informational purposes only to give you a sense of market movement and my opinion as to why. Although these rates exist today, based on certain qualifying characteristics (740+ fico, owner occupied SFR with 75% loan to value ratio or less), your scenario may allow for lower or higher interest rates. Licensed by the CA Dept of Real Estate, #01760965. NMLS: 239756. Equal Opportunity Housing Lender. If you’d like to be removed from this list, please reply with REMOVE in the subject line. You can also use this link, mailto:firstname.lastname@example.org and add REMOVE to the subject line. To add someone who would appreciate this information, send me their email with SUBSCRIBE as subject.
EZ Mortgages, Inc.
4535 Missouri Flat Rd. Ste. 2E
Placerville, CA 95667