Friday, October 26, 2012

Mortgage Liquidity, Liquidity, Liquidity

(Warning, this is a lengthy blog. I felt it was necessary to remind people of the value of the pre-subprime Fannie and Freddie, mostly before 2005, and the new reasons justifying consideration of the former GSEs ongoing national value as private entities. I could have broken it into two parts, but feared the loss of continuity. Thanks to my friend and former Bank Board and Fannie colleague, Gwenn Hibbs, for her legal and cynical eyes.)

President Obama and Mitt Romney are neck and neck, with less than two weeks to go before the Nov. 6 election.

The hard core votes for each man should balance and, if news reports are accurate, the race will be decided by women and those currently “undecided.”

The women and “Undies” driven by major social issues probably lean to Obama; those who care about the economy will lean to Romney, especially when they realize the former Massachusetts Governor will have a friendly Congress to work with, which Obama likely won’t.

I’ve blogged enough about the presidential election, so I want to turn to a more familiar matter, since it is an issue confronting the next Administration and Congress no matter who comes out on top.

What should America’s secondary mortgage market look like?

Right now, nobody cares because everything seems OK, with the federal government backing all the main players. But because of those taxpayer risks and costs, both political parties argue a change is needed.

A couple of developments have occurred which I believe lean heavily in a direction which won’t surprise many blog readers, but might open an eye or two among those hoping to make national mortgage policies.

Bye-Bye Uncle??

Can we ever get the federal government out of the conventional mortgage market? How might Fannie Mae and Freddie Mac make that happen?

A major part of the answer, first, is forcing the world to look at Fannie Mae anew, after decade of horribly bad press--much of it sensationalized and inaccurate--which started with a major lie. The negative momentum picked up as subsequent Fannie officials lost billions on very low quality mortgage investments and drove the enterprise into the ground.

Since then, matters have changed producing facts which checkers will find irrefutable.

As creatures of the federal government, since the Bush takeover in 2008 and now managed by the Obama Administration, Fannie Mae and Freddie Mac have managed 75% of all new conventional mortgage loans, which lenders sell into the secondary mortgage market. In fact, they’ve had the same market share—or slightly larger--for over three years.

It’s safe to say, Fannie and Freddie are the nation’s secondary market, because nobody else wants to manage it, given the responsibilities.

The only other industry large enough to take this mission from the former GSEs and their federal overlords is the commercial banking industry and bank actions scream they don’t want the job.

The Big Banks

Right now banks are happy; banks do not want to hold any conforming mortgages on their books, which the federal government doesn’t guarantee, nor do they appear to want to challenge F&F for the systemic obligation to keep money flowing on a steady basis throughout the nation—“in good times and in bad”-- by acquiring mortgage loans other institutions originate, i.e. the role of a secondary market maker.

The Federal Reserve’s two month old “Quantitative Easing 3” (QE3)—which the Fed hopes will stimulate the economy with its monthly $40 billion purchases of bank-owned mortgage bonds so banks have lower cost mortgage money—has freed billions of bank capital for mortgage lending and at low pass through rates for mortgage borrowers.

But many banks have chosen not to belly up to that free bar, saying they don’t have the staff to handle all of the potential new business those low rates can produce.

Maybe true--yet easily fixed--but the banks ain't bragging about the ton of cash they earn through arbitrage, putting the bond proceeds in overnight Fed accounts (about $1.5 trillion earning 25 bp) or buying Treasury securities.

With their actions, the banks display risk aversion and cite the pre-2008 real estate fiasco to justify not making bold new mortgage moves until the dust settles on what bank regulators as well as their own boards of directors expect.

F&F Still Chugging

At the opposite extreme in their current “quasi-government” lending role in the past three years, Fannie Mae and Freddie Mac—with Fannie carrying a larger burden of the two—have securitized nearly 8 in 10 of conventional mortgages originated in the United States.

In a harbinger of future black ink, both recently have posted solid earnings and publicly announced that no further Treasury financial help was needed in the near term.

Pouncing like a Soviet era apparatchik, the US Treasury then announced it was going to sweep every dollar the two earned, not just charge them the usurious 10% dividend on borrowings for its assistance. (Banks needing help only were charged 5 %.)

But the market operation's die is cast.

If  Banks continue to sit on the sideline (and why should get change, if they are being given such easy Fed money?), Fannie and Freddie in their ersatz form still will dominate the mortgage market, as policy makers wring their hands over that reality.

Please note, too, the F&F success is based on supportive—and at times strait jacket regulation—imposed by their safety and soundness regulator, the Federal Housing Finance Agency (FHFA). That agency requires that F&F only process low risk well. Underwritten mortgage loans. The mortgages have lender warranties affirming that borrowers have the means to repay those loans.

That kind of control was absent when Fannie got into deep trouble.

Why Fannie II?

Supporting my suggestion for a brand new look at something old is:

--Fannie and Freddie are a tested secondary market system well known to consumers and lenders;

--Fannie and Freddie have much improved oversight;

--There are no obvious or willing successors;

--Because of other governmental changes, most lower quality mortgages no longer go to F&F as conventional loans, but directly to HUD's  FHA guarantee insurance program;

--and most important to some, the “evil Democrats,” who used to freak the GOP, are long gone from Fannie Mae.

Now before all of the smirks and grins appear on wizened faces, contemplate this “wild card,” which few people in the nation’s capital seem to know and understand.

For the second time in five weeks--issuing a “summary judgment” decision in an eight year old shareholder lawsuit accusing former Fannie officials of violating security laws--Federal Judge Richard Leon found there was no evidence in the thousands of pages of testimony and filings which showed that Tim Howard, Fannie Mae Chief Financial Officer (CFO), did anything to break any securities laws or had any information that Fannie Mae broke those laws.

Previously, Judge Leon issued the same “summary judgment” decision” (dismissing him from the suit, as he did Howard) to Frank Raines, who was Fannie Mae’s Chairman and CEO from 1999-2004.
As my late mother used to cynically ask, "What’s that have to do with the price of tea in China?”

Lies and Damn Lies

Well Mom, and the rest of you chuckling, pointing fingers or rolling your eyes, those legal decisions mean that the single most devastating attack on Fannie Mae now has begun to unravel, because its only was a fabrication shaped less by reality and more by Fannie's business and political enemies, succored by the Bush Administration.

Worse, it fostered a situation, where good managers were forced out and Raines’ and Howard’s overmatched successors broke from the successful Fannie Mae norm--purchased unsound Alt A mortgages, ‘No Doc loans” (documentation), and worthless Wall Street originated subprime mortgage securities--and doomed the company and its shareholders, adding grist for the haters.

In 2004, as reporters and authors have documented, the Bush Administration utilized a variety iof actors and tactics and facilitated a Fannie Mae jihad (overused term, but quite accurate here).

A brewing conflict between Fannie and its sophomoric regulator then called the Office of Financial Enterprise Oversight (OFHEO)--renamed FHFA in 2008 legislation--pivoted around the company’s belief that OFHEO lacked technical competence and industry understanding.

In a thinly veiled retaliation, OFHEO issued a damning 2004 report alleging Fannie officials violated federal accounting rules, fooled investors, and used the manipulated numbers to support large yearend bonuses or as company opponents were quick to politically reduce it to (paraphrasing) “Fannie cooked their books and paid themselves big bucks.”

Fair Weather Friends

Company denials and solid rebuttals failed to assuage official Washington. When federal regulators imply fraud and deceit, the Capitol’s meek run to the sidelines while the feint of heart figuratively leave town.

That happened to Fannie Mae which immediately began to lose congressional, industry, interest group, community and consumer support, especially when the Bush SEC affirmed OFHEO’s finding.

By the end of 2004, Frank Raines resigned and Tim Howard did too.
Their successors, chosen by the Fannie board and the Bush White House, were not quite ready for prime time and made disastrous business errors leading to colossal failure and a Bush Administration 2008 takeover.

But the OFHEO report was false and the SEC confirmation equally so.

Professional careers, personal lives, and reputations were savaged and a well run institution, which was a major underpinning of the country’s mortgage system, stopped being so well run.
Given all these considerations, I believe that a review of what Fannie and Freddie did for the nation, leading up to 2005, argues for a “re-privatized” Fannie Mae and Freddie Mac, especially when the reviewer keeps one eye on Judge Leon’s findings doing the objective examination.

In all of the Fannie hate spewed it’s too easily forgotten--before the 2004 regulatory attacks and disruption began—that Fannie Mae worked successfully with a variety  of lenders and efficiently provided hundreds of billions in systemically safe and affordable mortgage financing, crowned by the ready availablity of the much desired 30 year fixed rate mortgage and its 15 year sibling.

I contend that only some ideologues will fail to see that times have changed and nobody wants the federal government up to its eyeballs in the conventional residential real estate market.

A Fannie in Your Future

Fannie and Freddie can be resurrected to serve what everyone hopes will be a housing surge that can produce economic activity and jobs across the country.

Done thoughtfully, after a statutory transition period to get from here to there, a President and Congress might agree that safe secondary mortgage market efficiency can emerge again without Uncle Sam financially standing behind it.

The new Fannie Mae and Freddie Mac must agree to a Treasury repayment scheme and going forward without federal financial support or lifelines.

I think even the nation’s major banks truly would love to have “new” institutions to which they can transfer the mortgage risk inherent in every loan eligible for Fannie/Freddie purchase.
They certainly do that now but with the federal government taking all of the risks. (Why is it that Conservatives never accuse the banks of “privatizing the profits but putting the risk to the federal government?”)

Congress Needs to Work Smart, Not Mean

Remaking Fannie Mae along these lines will bring private capital back into the mortgage market, faster than anything else Congress can create with that objective.

No matter what the Congress says in statute, I know that “Mr. Market” in the future could look back to 2008, when Fannie and Freddie and big and small financial institutions were helped by Uncle Sam. Those institutional investors still could assume that the mortgage sector is too big to fail and the feedral government will just write checks the moment there is trouble.

None of us can erase that history, so the market will just have to learn the hard way if the Congress declares in law that Fannie and Freddie or other major mortgage investors are not backed by the federal government and then acts accordingly.
With continued expert oversight, the federal government can get out of financial responsibilities for every conventional mortgage which Fannie and Freddie could finance.

The lender and systemic familiarity with Fannie and Freddie still exists. The solid regulation—keeping bad loans out of the process--is in place. The demand is growing. The efficiency is there and Judge Leon has provided a new perspective on well know actors.
All that is missing is an Administration and Congress trying to reinvent the wheel and opt for an easy transition from the old government model to one minus Uncle Sam’s copious support.
Official Washington talks the “private mortgage real estate capital is needed” talk, so now it should walk the walk.

President Obama or Governor Romney, think about what I’ve proposed and get back to me!!

Maloni, 10-26-2012


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