So Fannie and Freddie Weren’t the Problem…

Popular Economics Weekly

We are learning just how much mortgage fraud was committed by 17 national and international banks and other financial entities that the Federal Housing Finance Authority (FHFA) originally sued to recover some $200 billion in losses to the GSEs that it regulates, Fannie Mae and Freddie Mac.

This tells us where the real faults lies for the credit bubble that led to the housing bubble.  The once private stock corporations and now wards of the government, Fannie Mae and Freddie Mac, didn’t precipitate the housing bust.  They weren’t even the main issuers of faulty mortgages that imploded with the Great Recession. It was the federally-supervised commercial banks themselves that misrepresented many of the mortgages it sold to Fannie and Freddie, thereby giving them the cover of AAA rated assets, when they were much closer to junk bond quality.

Fed Chairman Alan Greenspan had lowered short term interest rates below what was the inflation rate at that time—some 3 percent—whereas his fed funds rate was as low as 0.5 percent.  (That meant if money was lent at below the inflation rate, it was basically free money because inflation would eat away at the amount owed so that it was actually worth less when paid off, or sold, than the face amount of the debt.)

And banks jumped into the housing bubble that resulted, almost ignoring the most basic lending safeguards from such ‘free’ money, such as verifying income and assets of the borrowers that Fannie and Freddie required.  In other words, Fannie and Freddie guaranteed that nothing was “stated” on the loan application that wasn’t verified.

The GSEs themselves were also at fault for allowing mortgage banks such as Countrywide Financial (acquired by Bank of America) to package and sell Mortgage Backed Securities to Fannie and Freddie that mainly consisted of negatively amortized ‘liar’ loans with very low initial payment rates, and little or no income and asset verification.  But that was a small portion of the defaulted loans, and in fact Fannie and Freddie guaranteed mortgages have far and away the lowest default rates.

Wall Street insiders now believe that up to $50B could be the tab to settle all the pending cases, according to the New York Times.  Some $1.96 Trillion in so-called private-label mortgages were issued by banks from 2005 to 2008 during the height of the housing bubble, according to the latest figures.

As of January, the FHFA has settled six of the private-label RMBS cases, recovering nearly $8 billion for taxpayers.  Whether due to a lack of adequate supervision, or outright fraudulent misrepresentation of the credit quality of those mortgages, these banks sold Fannie and Freddie mortgages that didn’t meet the strict credit standards of the GSEs.

Graph: NY Times

Banks such as JP Morgan Chase ($5.1B), Deutsche Bank ($1.9B) and now Credit Suisse ($885B) have settled, while admitting they had inadequate oversight.  But Bank of America and Goldman Sachs are holding out, so are going to trial sometime in midyear 2014. 

Others that have settled include, GE (Ally Bank), United Bank of Switzerland and Citigroup.  They had failed to prove in federal court that the mortgages underlying their Mortgage Backed Securities sold to Fannie and Freddie were due to the busted housing bubble that caused the loss of some $5 Trillion in real estate values, rather than their faulty underwriting practices.

Twelve of the cases remain, including FHFA’s lawsuits against Barclays Bank (BCS), Bank of America (BAC), Credit Suisse Holdings (CS), First Horizon National Corp., Goldman Sachs & Co. (GS), HSBC North America (HSBC), Merrill Lynch & Co., Morgan Stanley (MS), Nomura Holding America (NMR), SG Americas (Societe Generale), The Royal Bank of Scotland Group (RBS) and Countrywide Financial Corp.

So don’t blame Fannie and Freddie for wanting to expand home ownership, as those who oppose government ownership or regulation of anything have contended, and seem to have convinced the Obama administration.  They were as much a victim of deceptive lending practices as the borrowers and homeowners who lost out due to the resulting Great Recession.

Harlan Green © 2014

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Saving Fannie and Freddie Mac

The Mortgage Corner

Fannie Mae (FNMA), or Federal National Mortgage Association, reported a record profit for 2012, a good reason to save the mortgage giant from dissolution, as the banking industry in particular has lobbied for. The government-sponsored enterprise had net income of $17.2 billion for 2012, outpacing profits at S&P 500 companies such as Wal-Mart Stores Inc. (WMT), General Electric Co. and Berkshire Hathaway Inc. (BRK/A).

Fannie Mae’s net income for 2012 compared with a loss of $16.9 billion in 2011, the company said in a statement. Profits totaled $7.6 billion for the three months ended Dec. 31 after accounting for a $4.2 billion dividend payment to the Treasury Department for the government’s stake. So it can begin to payoff the $188 billion borrowed from the U.S. Treasury to keep the mortgage industry—and so housing—afloat.

There is another reason to save Fannie Mae and Freddie Mac from complete dissolution. Their underwriting standards are the highest and have resulted in the lowest default rates of all mortgages. Fannie Mae reported that the Single-Family Serious Delinquency rate declined in February to 3.13 percent from 3.18 percent in January. The serious delinquency rate is down from 3.82 percent in February 2012, and this is the lowest level since February 2009. Its serious delinquency rate peaked in February 2010 at 5.59 percent.

Graph: Calculated Risk

Fannie Mae serious delinquencies averaged below 1 percent until 2008, the beginning of the housing bubble bust. Whereas the average delinquency rate for all Private Label Mortgages today is 6.8 percent, as many of them are the so-called liar loans that didn’t require either income for asset verification.

Earlier Freddie Mac (FHLMC), or Federal Home Loan Mortgage Corporation, the other GSE under government conservatorship, reported that the Single-Family serious delinquency rate declined in February to 3.15 percent from 3.20 percent in January. Freddie's rate is down from 3.57 percent in February 2012, and this is the lowest level since July 2009. Freddie's serious delinquency rate peaked in February 2010 at 4.20 percent.

Banks have been lobbying for years to either downsize or abolish the government-owned GSEs, as we said. But that would be throwing out the baby with the bathwater. For it was subprime lending that created the housing bubble with it minimal or nonexistent qualifying criteria, such as the ‘stated income’, or ‘no income’ verification requirements of so-called Option ARMs that allowed minimal payments for the first 4 years, before payments rose enough to begin to pay down principal balance.

Their argument has been that Fannie and Freddie are taking business away from private banking. They have claimed that the “implicit” government guarantee against default of the GSEs has given them a profit edge. But without Fannie and Freddie, there would be no viable housing market. We know this because of what banks did in the 1980s, when Fed Chairman Paul Volcker raised interest rates into double digits.

Banks then withdrew almost completely from mortgage lending, so the GSEs stepped in by creating a secondary market that packaged and sold mortgages to investors—either to Wall Street, or Main Street pension funds. That enabled the real estate industry to recover from the 1981 and 1983 Reagan recessions.

So the banking industry has been very fickle when it comes to mortgage lending. In fact, the subprime fiasco resulted from overleveraged banks taking advantage of soaring housing prices at the same time that financial markets were deregulating. Banks created the so-called shadow banking system outside of any regulatory oversight, which is responsible for much of the shadow housing inventory still on their books—an estimated 5 million homes either delinquent or with negative equity in their homes in danger of foreclosure.

There is in fact good reason for banks to lend again with interest rates still at record lows and housing prices beginning to rise again. A mortgage banking industry has grown around the secondary market, and as long as banks will adhere to the same gold standard underwriting as Fannie and Freddie, there is no reason they shouldn’t be generating record profits, as well.

Harlan Green © 2013

Follow Harlan Green on Twitter: www.twitter.com/HarlanGreen

WHY THE FIXED RATE PREFERENCE?

Fixed rate mortgages continue to be the financing of choice, in spite of former Fed Chairman Greenspan’s attempt to sway borrowers towards adjustable rate mortgages, or ARMs. Studies from the Federal Housing Finance Board, which regulates savings and loan institutions, show that more than 80 percent of mortgages tend to be fixed-rate products versus 18 percent that are adjustable.

This puts the current adjustable rate subprime crises in proportion, since subprime loans comprise just 6 percent of outstanding mortgages, though their default rate is approaching 20 percent. The default rate for all conventional mortgages is now 6 percent.

"The fixed-rate mortgage is a cornerstone of the U.S. housing finance system and has been instrumental to the accrual of wealth on the part of many households. The low interest rates of the past two years have increasingly lured consumers seeking a predictable payment in an uncertain economy," said Stuart Gabriel, director of the University of Southern California Lusk Center for Real Estate.

The 30-year, fixed-rate mortgage is about 70 years old. The loan instrument was first offered during the 1930s after the creation of the Federal Housing Administration as part of financial reforms to combat the Depression.
Before that, most residential loans were balloons, requiring a payoff within 10 years. In addition, mortgages were made for only up to 50 percent of a property's value.

Long-term loans took off in the housing boom post World War II, when FHA and VA mortgages fueled construction in U.S. suburbs. At the same time, homeownership rates jumped once the 30-year loan became available, from 44 percent in 1940 to 65 percent in 1966; the rate is near 68 percent today.

Adjustable-rate loans have their advantages when fixed interest rates are high or rising quickly. But the subprime debacle showed us that using them when interest rates were at record lows 2003-2005, lulled borrowers into a false sense of security. The Federal Reserve under Fed Chairmen Greenspan and Ben Bernanke raised short term interest rates 17 consecutive times over 2 plus years, which burst the real estate bubble and caused the credit crunch we have today.
ARMs first became widely available in 1981, their share of the mortgage market has varied from a high of 39 percent in 1994 to a low of 12 percent in 2001, Gabriel found.

"Clearly, borrowers benefit from the availability of a wider variety of products. ARMs appeal to more mobile households, homebuyers who expect their incomes to be positively correlated with interest rate fluctuations and buyers who are down payment-constrained," Gabriel wrote. But if affordability of the monthly payments isn't a problem, "then many borrowers prefer the ongoing payment certainty of the fixed-rate loan."

There are some regional differences in the use of fixed-rate vs. adjustable-rate mortgages. Consumers in Alaska are most enamored of the fixed-rate mortgage: In 2003, 98 percent of conventional home mortgages in Alaska were fixed-rate mortgages.
Following Alaska in favoring the fixed-rate mortgage are Delaware (93 percent), Oklahoma (92 percent), Texas (92 percent), New Mexico (91 percent), Pennsylvania (91 percent) and Tennessee (90 percent.)

Homebuyers in Massachusetts are most likely to take an ARM; 32 percent did so, in part due to the higher price of homes. Other states where adjustable loans command a high percentage of the market: Colorado and Michigan, with 30 percent; California, 29 percent; and Illinois, 27 percent.

© Harlan Green