Wednesday, May 2, 2007

The Helpful GSEs

The Helpful GSEs

A small, but significant, turn of events in the past few weeks seems to have cast the first sunshine on the GSEs in years.

The subprime mortgage problems, largely a result of aggressive brokers and lenders, selling, through Wall Street, “private label” mortgage backed securities—backed with crappy loans--seemingly has underscored the quality of the more traditional Fannie/Freddie services and mortgage products.

About two years ago, Alan Greenspan highlighted concerns about “subprime,” but then not only dropped the ball—with zero follow up--but seemed to lose it completely. Then, when subprime borrowers started missing their payments, because of rate escalation clauses and other whiz bang special features, and began defaulting in serious numbers, the Fed couldn’t put out the fire or the GSEs, since there was too much responsibility for the inaction at 20th Street and Constitution Avenue, where the central bank resides.

Freddie Mac and Fannie Mae, in that order, have emerged from the subprime dilemma, somewhat, as the good guys and part of the solution. Each has pledged upwards of $20 billion to refinance and restructure as many of these loans as practical, saving families’ homes and also, the Congress, which now doesn’t have to figure out how to fix the mess, since the “private sector” now will take it on.

Kudos go to Dick Syron and Dan Mudd.

A Mortgage Market Without The GSEs is….

t remains to be seen if Congress sees the real mortgage finance system message, in the subprime mess.

A mortgage market, without the Fannie and Freddie governance, is as untamed as a lawless, Old West frontier town. The mortgage market gunslingers and con artists--without a Sheriff present--will take advantage of the people, constantly.

That fact is why, as Congress moves to reregulate both companies, it should be very, very cautious in heeding the word of the GSE business opponents, the Administration, the Fed, and the conservative think tanks and their congressional allies, who want the GSEs out of the “A” market, so the large commercial banks can run roughshod over it.

One other aspect of this market event--which the nation will survive, and which will hurt some of the “bad actors,” but won’t deter all of them--are the others excesses in the subprime and regular “A” markets that cry out for relief and which might benefit from congressional attention and greater GSE business involvement.

Three come to mind, appraisals, title insurance, which is a “toughie,” and mortgage insurance. The Congress easily can deal with the appraisal and mortgage insurance issues, but “title” has too many fat piggies at the trough and its regulation is dispersed beyond the states to the communities.

But, there are better ways and far cheaper ways to provide each--some of which the GSEs can do--if Congress was supportive.

Appraisals, title insurance, and mortgage insurance, all necessary--in one form or other--when mortgages are created, could be provided more cheaply, if the laws and regulations requiring them were updated and open to real competition.

Title Insurance

In no particular order of greed, title insurance—which costs from $500 to $2000 a policy, paid at closing—reflects merely a bunch of lawyers covering each others butts, by telling you that nobody has filed a lien against your property and, that the last lawyer who looked at the same data, didn’t screw up.

Nobody wants to purchase a home which had a hidden lien against it, and jeopardize clear title to what you just saved and scrimped to acquire. So, some title review is necessary. But, this nearly $20 billion a year industry, which has annual claims of less than 5%, bitterly opposes all suggestions of consumer friendly changes. The Government Accounting Office (GAO) just has issued a report on this excess, filled with damning numbers.

Now, when deeds were filed by hand with the county clerks who hand wrote most mortgage purchase details, there could be some justification for this “lawyer’s relief industry” providing a service, albeit far cheaper.

But, today, with growing electronic recordation of deeds and—more importantly—a huge technology driven secondary mortgage market, insuring “clear title” can be done more simply and for something on the order of $50 a policy. This is where the federal government should step in and make title insurance or its equivalent, a federal requirement, subject to federal rules.

The competition and breakthroughs that would greet Congress stepping up here would knock down the price of title insurance to $100, or less.

But, small relief can occur, until the title process escapes the clutches of state and local regulation, where a “you scratch my back, I’ll scratch yours” ethos controls this hugely bountiful process.

(For more on this little darling, see Forbes magazine, “America’s Richest Insurance Racket,” November 13, 2006. which noted one possible Senate Financial Services Committee roadblock to changing this industry.)

Mortgage Insurance

As originally conceived, mortgage insurance was a superb, consumer friendly idea. The policy made up for what money you didn’t have for a down payment.

The industry blossomed with the creation of the modern Fannie Mae, in 1970, when Congress permitted the now “privately owned” mortgage investor to buy conventional loans, i.e. those not insured or guaranteed by the federal government. The idea was simple and sound enough and based on the 1960’s way of doing mortgage finance, i.e. forty years ago, lenders required much larger down payments.

Congress wanted to make sure that Fannie Mae did not finance (buy for portfolio) loans that were too risky. “Risk” was defined as how much equity a borrower had in his or her home. The Congress determined that 20% was the correct number and said that Fannie could buy loans where the mortgagor had put down 20% or—acknowledging that 20% was a pretty big slug of cash for most borrowers—had “mortgage insurance policy.” That borrower paid policy covered the difference between what the borrower put down and what amount represented 20% of the home’s purchase price. The policy was payable to the “mortgage investor” (Fannie Mae), should there be a mortgage default, with the policy covering a piece of the losses.

For many years, the MI made the difference and allowed people of modest means to buy homes through a combination of what they could afford for a down payment and the 20% spelled out in federal law, which became kind of a norm, whether Fannie (and later Freddie) bought the loan or not.

But, as the secondary mortgage market became more efficient and itself required less and less of a down payment, the MI requirement stayed, because the “small” MI industry (6-7 companies, nationwide, at any time) successfully challenged efforts to change it.

While Fannie Mae and Freddie Mac both looked at ways to do away with MI, since it existed only for their protection, it was Freddie—with the generally more aggressive Fannie, staying on the sidelines—which moved to save the consumer that monthly premium, by initially getting its charter changed to allow the company to provide a cheaper form of mortgage insurance, bypassing the MI industry.

Ultimately, the Freddie effort failed, when the MI industry awakened to what had occurred, and managed to get the amendment dropped.

Ironically, that incident led to the formation of the MI facilitated FM Watch group, which became one of the loudest GSE critics, over the years.

The bottom line is that the GSEs easily can figure out ways to insure or self insure their loan acquisitions and mortgage backed securities, saving the mortgage consumer undressed of dollars annually, but the MIs are holding onto their little piece of inefficiency and doing a good job of it.


In theory, an “appraiser” goes out to examine home for sale, when a potential buyer seeks financing and the appraiser, either an employee of the lender or an “independent operator, “offers a judgment if the home, minus and proposed down payment, is worth what the borrower is seeking.

The practice costs the borrower generally $500 or so. That's way too much for way too little.

Suggestions of collusion between appraiser and lenders has been rife for years, with the appraised value of the home often hitting, right on the head, the sales price.

Fannie Mae and Freddie Mac, both, allow lenders to use the companies’ automated underwriting standard and the plethora of local data and values to produce an appraisal estimate. If a “site visit” is necessary to substantiate that figure, a lender could send an employee or contractor out to look at the house and weigh in on the suggested valuation.

Savings of $400 or $500 on an appraisal, savings of $2,000 on title insurance, and one or two years at a deeply reduced MI premium, possibly saving a family $3000 to $5000 over the life of a mortgage insurance policy, could mean the difference between buying or not buying a home for many American families.

As Congress seeks to shape the GSEs to, in turn, shape the large bank dominated primary mortgage market, it should consider these matters.

(Oddlot: Why is it that I think Jim Lockhart’s nose got longer, when he was quoted as saying that he didn’t mind if Gene McQuade succeeded Dick Syron?)

1 comment:

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