In Monday’s, first piece of this blog, I established why—in my opinion—the Congress has already created a very efficient and fair secondary mortgage market, around the services of Fannie Mae and Freddie Mac-- and why, following some regulatory changes to their capital structure, portfolio limits, and slight mission change, the two could help resurrect the nation’s conventional mortgage market, far smoother and far faster than anything totally new which Congress could create in the next few years.
It’s an uphill slog convincing the Congress of this because of all of the misinformation about what happened in 2007 and 2008 to the GSEs, but it’s a case that Congress needs to hear and understand.
I also argued that the GSE regulatory regime needs remodled, primarily with new personnel. The Federal Housing Finance Agency (FHFA and its predecessor OFHEO) never has been subject to this kind of efficiency audit and needs to be if Congress wants it to do the job of properly overseeing Fannie and Freddie or something new created by statute.
I ended the Monday segment asking observers to look at the years 2002-2007 as the best and worst of the GSEs and using that microcosm, decide what mortgage market changes were necessary.
Let me short hand those years for you and point out some major issues.
Fannie and Freddie didn’t create themselves. They were designed by Congress (with that model being extended by Democrat and Republican Congresses and Administrations for over 35 years) to fund their own operations, employing private market discipline as made and to provide a secondary mortgage market for low moderate and middle income families, meaning buy mortgage loans from banks, thrifts, mortgage companies and other primary market lenders, which served that demographic.
Until the 1992 law which created the new “risk based capital” rules and OFHEO, HUD oversaw (and has for the past 18 years) achievement of the company's "housing goals," most of which now have been relaxed in with the GSEs in "conservatorship."
Before the 1992 statute, 30% of the GSE business had to serve that group, and then the bill made that 40% with HUD given authority to increase it. Andrew Cuomo, Bill Clinton's HUD Secretary and current NY Attorney General, pressured Fannie and Freddie to do “more” and gradually raised that number so that a whopping 55% of their business volumes had to serve “goals business.”
George W. Bush did his share, too, to try and shackle Fannie and Freddie when his HUD Secretary dramatically shrunk which financed units could be counted towards those goals.
But the key point is that all of the low and moderate income mortgage finance did not financially injure the GSEs. The low-mod, housing loans performed almost as well as the remainder of Fannie's business, which served a higher income cohort but which still fit the low-mod mission obligation.
(Question for the Congress? What conventional lenders—under the law--are responsible for lending to low and moderate income families and people of color, refinancing them, or restructuring their bad loans? Now that Fannie’s and Freddie’s goals have been relaxed and the two companies hobbled, the large commercial banks and their subsidiaries haven’t stepped in, which mean those folks aren’t being supported. See this past Sunday’s Washington Post front page. Link follows.)
Wall Street Brings Bad Times for the GSEs and the World
In the early years of this decade, Wall Street got directly into the mortgage origination business--in a major way--competing with the GSEs. The “Street firms” (large investment banking houses and commercial banks) figured they could make more money by excluding Fannie and Freddie and their proven underwriting technology and systems, so Wall Street employed an army of mortgage brokers who wrote mortgage applications for thousands who never would have qualified under the GSE system. But the brokers got paid for every loan they produced, so quantity, not quality, became their imperative.
The Street investment banking firms wrested from the GSEs a large segment of the mortgage market, turning those loans into "Private Label Securities" (PLS), broke those bonds into hundreds of component boutique pieces, selling them to institutional investors throughout the world.
What brought the GSEs down was an elixir that they didn't invent or invite, yet it was a drink which they supped heavily. The business mistakes that Fannie and Freddie made were decisions by their former CEOs (Dan Mudd and Dick Syron--worried about losing market share and revenue to Wall Street--to buy those doomed and poorly underwritten, high yielding PLS securities for their mortgage portfolios.
They were a financial time bomb.
It wasn't the GSE structure or low-mod housing mission which brought them down, but it was acquiring the toxic "subprime" assets--the very name of which indicates their below market quality--compared to the traditional Fannie and Freddie purchase of "prime" loans. The PLS subprime mortgage loans were so poorly underwritten by the Street's brokers that the slightest economic downturn started an avalanche of missed payments and ultimate defaults, which swamped the originating guarantors and their PLS investors, some of the strongest financial names in the world.
Low Income Loans Didn’t Burn Fannie and Freddie
Look closely. Very little of the “prime” mortgages and securities owned by the GSEs went bad. Very much of the PLS subprime did and still loses money.
Congress shouldn’t waste time arguing about the low-mod mission. Nothing about it was unreasonable, except the overly large percentage of business demanded, which is why I suggest trimming it by 20% or so, not doing away with it.
Fannie and Freddie showed that obligatory low-income mortgage lending can be done and was done, quite efficiently. The GOP will howl and insist helping the poor was part of the GSE problem. It wasn't and they shouldn't be given standing with that corrosive rhetoric.
Severe individual sanctions were meted out to the former GSE officials who made the colossally poor PLS purchase decisions. Fannie's and Freddie's common stock fell the $60's to about a dollar, where it sits today, crushing their investors. Other GSE employees were fired, embarrassingly and publicly, and some hounded from jobs, with their reputations damaged, income and benefits all lost.
But previous managerial failings and human shortcomings at Fannie and Freddie shouldn't cause Congress to ignore the nation's primary and secondary mortgage system's strong points.
I've suggested a way that Congress and the Administration can responsibly rebuild the nation's mortgage finance system and avoid making themselves subject of ridicule or even voter hostility for laboring long, angrily, and producing a nothing burger.
I hope someone is listening on the Hill and downtown.
(Here’s a strong piece by Paul Jackson, in Housing Wire, that was sent to me just after I posted Part 1 of this blog.)