Contrary to appearances in the nation’s deadlocked capital, there’s been a lot going on in housing finance lately. In September, the Federal Housing Finance Agency (FHFA) proposed raising the guarantee fees, or g-fees, charged by Fannie Mae and Freddie Mac for carrying non-performing loans in five states by as much as 30 basis points. That would be the third time in a year that the FHFA has raised g-fees, in an effort to align them more with the private market and reduce Fannie’s and Freddie’s risk in high-foreclosure states.
The FHFA also recently launched a new representation and warranty framework for conventional loans sold or delivered after Jan. 1, 2013. That new structure relieves lenders of certain repurchase obligations on loans whose borrowers are current in their payments for 36 consecutive months, and could loosen up lenders to make future loans to more borrowers.
And by next January, the Consumer Financial Protection Bureau (CFPB) is expected to come out with its definition for qualified mortgages under the Dodd-Frank financial reform act. Once that’s issued, regulators can put forth rules governing qualified residential mortgages (QRM), which as proposed would require 20 percent down payments on loans where there’s not at least 5 percent risk retention when securitized.
Builders and real estate agents have lobbied lawmakers to lower down payment requirements for QRMs to about 10 percent. But QRM debates pale beside the uncertainties that surround the impending transition of Fannie and Freddie to some form of private entities.
What comes after Fannie and Freddie—which have been wards of the federal government since September 2008—is of great concern to builders and their customers, given that those two entities and the Federal Housing Administration (FHA) guarantee 91 percent of all new mortgages being written these days. “Fannie and Freddie worked beautifully for decades, so they won’t go away entirely,” predicts Doug Yearley, CEO of Toll Brothers, whose mortgage subsidiary captures 70 percent of Toll’s buyers who typically put down 30 percent on a house with an average selling price of $670,000. “Everyone recognizes that we need some government involvement, and I’m optimistic that any changes will be eased in sensibly because two-thirds of this country owns a house and you need to provide free-flowing credit.”
In fact, some mortgage lenders, mortgage insurers, and at least one government agency see a reconfigured housing finance market as a growth opportunity (see “Stepping In,” opposite page).
Consensus about what’s next seems to be emerging from proposals that the government and various housing and financial organizations have put forward recently (see “Try This,” page 46): That an explicit government backstop is essential to maintain liquidity in the mortgage arena; and that the private sector must assume more lending and securitization risk. A new mechanism for securitizing mortgages, with stiffer regulations, also is being touted “to keep the crazier stuff out,” says Dave Ledford, NAHB’s senior vice president of regulatory affairs, about exotic mortgages with no down payments or document verifications that got the industry and homeowners into trouble in the first place.
But how these and other proposed changes will be achieved is still pretty vague. “If you just say ‘GSE reform,’ what does that mean?” asks Bob Schottenstein, CEO of M/I Homes. “Change what to what?” And virtually no one can state definitively how long winding down Fannie or Freddie would take. “It’s next to impossible to talk about a timetable when [Fannie and Freddie] guarantee two out of every three mortgages, and the Treasury Department is using them to generate revenue,” observes Guy Cecala, publisher and CEO of Inside Mortgage Finance.
James R. Hagerty, a Wall Street Journal reporter whose history of Fannie Mae was published in September, cautions that based on precedent, any major decision about transforming mortgage financing could take a very long time to resolve. “Just about everyone agrees the old system was a mess, but replacing it gets difficult and the details are of interest to so many parties, all with different agendas.”
The next resident of the White House could have a big say in how such reforms play out. This article is being written in October, at which time Republican presidential hopeful Mitt Romney signaled his preference for far less government involvement in housing finance than a second Obama administration probably would lean toward.
Cecala and Stan Humphries, chief economist of the real estate search engine Zillow.com, agree that the easiest path to reducing the GSEs’ footprint might be to lower their loan limits to at least $417,000. But it’s doubtful that either political party would take a more radical leap toward limiting the government’s financial backstop for mortgage securitization to the point where it endangers the 30-year fixed-rate loan that many Americans see as their God-given right (even though relatively few actually stay in any one house for three decades) and whose elimination the NAHB views as “a deal breaker,” Ledford says.
As many industry officials call for private entities to supplant Fannie and Freddie, some others still argue that downsized versions of the existing GSEs would be fine with them. “If you eliminate 1998 to 2006, we had the best housing system for decades,” said David Stevens, CEO of the Mortgage Bankers Association, in an interview with Bloomberg BusinessWeek published in October 2011. “Coming out of this market, it may be easiest just to keep a more limited Fannie and Freddie operating, almost as they are today.”
During a September broadcast of the online radio blog Lykken on Lending, Don Brown, a principal with the Denver-based risk management firm Secondary Interactive, predicted that Fannie and Freddie would be “wildly profitable again” as a result of “vanilla-safe” lending that Brown believes should be their wheelhouse going forward. He fears that without some kind of standardizing body, the industry would retreat to portfolio or private mortgage security lending, where standards are set by “different entities that are purchasing, holding, or securitizing the loans.”
“We lead the world in the liquidity of our banking industry, and to lose that edge would be a big mistake,” Brown asserted.
ATTRACTING PRIVATE CAPITAL
In August, the Treasury Department revised its preferred stock purchase agreements with Fannie and Freddie, requiring the GSEs to turn over any profit to the government, which has pumped more than $180 billion into these entities since they’ve been in conservatorship. However, the likelihood that taxpayers ever will be fully remunerated is slim to none. “The Enterprises’ losses are of such magnitude that the companies cannot repay taxpayers in any foreseeable scenario,” wrote the FHFA in its strategic plan for the GSEs in February.
On principle, most industry watchers don’t think it’s a good idea for the federal government to be dominant in a market that’s securitizing $100 billion in new mortgages per month. And by continuing to purchase bonds (into which securitized mortgages are being converted) to hold down interest rates, the Federal Reserve is dissuading private investors from re-entering the housing finance market in greater numbers.
“There’s no risk-reward value proposition that’s appealing” to investors, says Daniel Jacobs, president of retail branching for the Charlotte, N.C.-based mortgage lender Residential Finance Corp. “For the housing industry to experience the type of recovery that people are expecting, we have to have make-sense lending outside of the government straitjacket.”
Humphries thinks private money will re-enter the market “where there’s a sufficient price point. The question, though, is how many people will be able to afford that price.” At the very least, mortgage interest rates will need to come up to attract investors, says Paul Leonard, senior vice president of government affairs for the Financial Services Roundtable’s Housing Policy Council. And Dan Klinger, president of K. Hovnanian American Mortgage Co., expects to see investors flocking back to housing finance when “appropriate due diligence demonstrates that the borrower isn’t a big risk. That’s already happening.”
You can say that again. K. Hovnanian American now verifies borrowers’ documentation six different ways, including checking their current and previous employment, their W2 and 1040 filings for the past two years, and requiring multiple pay stubs. All of that checking gets repeated at closing. “The biggest challenge for us is setting customers’ expectations, so they don’t kill the messenger,” Klinger says.
He notes, too, that between a sale and its closing, customers must explain every non-payroll deposit over $300, an imposition to which many buyers take umbrage. “One of our loan officers showed me a photo of a quarter and two pennies that a customer sarcastically said he found on the floor that morning and was reporting ‘proactively,’” Klinger recalls. Consequently, more of Hovnanian’s buyers than ever—particularly active adults—are choosing to pay cash than subject themselves to this strip search.
FINDING A REGULATORY BALANCE
While they’ve generally supported new regulations, builders insist the pendulum has swung too far to where excessive restrictions are preventing qualified borrowers from obtaining mortgages. Builders also wonder what other unintended consequences might be lurking behind mortgage finance reforms.
Paul Rosen, president of M/I Financial, points out that the CFPB is considering regulations that would treat affiliated entities differently from non-affiliated entities. So M/I Financial would have to show that its annual percentage rate for mortgages is higher than competitors’ because it includes fees from affiliates such as M/I’s title company. Consumers would have to pay for title insurance regardless of their mortgage provider, but such upfront disclosure “could make some of our loans unmarketable,” he laments.
This being said, Rosen remains convinced that, no matter what happens to the GSEs, the U.S. will continue to provide a method for financing homes “that will be the envy of the world. It will be pro consumer and pro industry.”
But it might be years before the dust finally settles. Ken Gear, executive director for the Leading Builders of America, expects it could take 18 months after the next president is elected before a bill emerges in Congress that lays out the transition of Fannie and Freddie (or some variation thereof) into private-sector entities, and another five to seven years before the changeover is complete.
In the meantime, Gear recommends that builders continue to educate their elected officials about the ramifications of any mortgage reforms on the housing industry because, he states, “the complexities of housing finance are lost on most members of Congress.”