Secondary Mortgage Market Policy Fannie Mae to QRM Kevin Park PLAN 761 September 19, 2012
History of Mortgage Lending
Traditional Bank Lending e.g., Bailey Building and Loan Association Mortgage Payments Interest Title Borrower Bank Saver Loan Deposits
The Secondary Market Closed residential mortgages or mortgage securities bought and sold Mortgage Payments Title Servicer Borrower Lender Investor Loan Investment
The Concept of a Federal Mortgage Association While we believe that most desirable and effective governmental control could be obtained through special Federal charter for a new organization to finance urban real estate, the prospect of securing legislation is admittedly not a rosy one It might be possible to arouse Congressional sympathy for the poor folk who wish to buy their own hones, as it was aroused for the poor farmer, but as for improving urban financing in general it is doubtful if it is possible to give the subject enough sentimental appeal to overcome and (sic) double resistance against what is considered government paternalism on the one hand and against the further extension of Federal action on the other
By making it possible, however, for borrowers everywhere to obtain money on good security at low rates, it would do all that can be done to [bring the loan rates of local lenders all over the country to a uniform level] It might, in addition, serve as a central market for the purchase and sale of highgrade mortgages with great benefit to the liquidity of this type of security No doubt such an institution might do much to check the use of improper or unsafe methods by other lending agencies It might take so large a part of the whole field as to crowd out many weak and questionable concerns A new institution would certainly not eliminate from competitions concerns with which its standard would not allow it to compete. John H. Gray and George W. Terborgh. First Mortgages in Urban Real Estate Finance. Brookings Institution 1.2 (1929).
The Great Depression Before the 1930s, many homes financed with interestonly, 3- to 15-year mortgages. Great Depression exposes credit and liquidity risks of traditional bank lending. National Housing Act of 1934 creates FHA to insure mortgages for a fee to be paid by borrower. Also authorizes FHA to create a government agency to purchase these federally-insured mortgages Federal National Mortgage Association ( Fannie Mae ) chartered in 1938.
Post-War Era Banks and thrifts remain dominant form of mortgage financing for another 40 years. Share of Home Mortgage Debt Outstanding, 1968 22% Commercial Banks and Thrifts 2% 5% Federal Government and Government- Sponsored Enterprises 71% Finance Companies and Private-Label Securities Issuers Other Source: Federal Reserve, Flow of Funds
Quasi-Privatization Vietnam War and Great Society programs increases federal government outlays. Fannie Mae privatized in 1968 to move debt off budget. Becomes a governmentsponsored enterprise (GSE). ( Ginnie Mae created to continue buying FHA mortgages). Federal Home Loan Mortgage Corporation ( Freddie Mac ) created in 1970.
Share of Home Mortgage Debt Outstanding Source: Federal Reserve, Flow of Funds; Historical Statistics of the United States; National Association of Realtors ; Census Bureau Rise of the GSEs Fannie and Freddie fill the void left by banks and thrifts after Savings & Loan Crisis. Implicit government guarantee substitutes for explicit deposit insurance. 80% Share of Home Mortgage Debt Outstanding, 1970-2000 60% 40% 20% 0% 1970 1975 1980 1985 1990 1995 2000 Commercial Banks and Thrifts Federal Government and Sponsored Agencies Finance Companies and Private Securities Issuers Other Mortgage Debt Holders
The GSE Model GSEs issue bonds (later mortgage-backed securities) to raise capital to purchase mortgages. Conventional: not government insured (not FHA/VA) Conforming: debt-to-income limits, documentation requirements, maximum loan amount ($417K from 2006-2009). Freddie Mac issues first mortgage pass-through or mortgage-backed security (MBS) in 1971. (Fannie Mae did not issue first MBS until 1981). Incorporate credit scoring and automated underwriting (AU) systems in early 1990s.
Profit! GSEs retain 35-37% of value of implicit government subsidy. Market Capitalization Source: Financial Crisis Inquiry Commission
Affordable Housing Goals Federal Housing Enterprises Financial Safety and Soundness Act of 1992 creates affordable housing goals: Low- and Moderate-Income Goal Individuals earning no more than the area median income. Underserved Areas Goal Individuals residing in lower income areas (90% of area median income in metropolitan areas), or higher minority areas (minority share 30% or more and median income no more than 120% of area median). Special Affordable Goal Individuals earning no more than 60% of area median income or residing in low-income neighborhoods and earning no more than 80% of area median.
Goal Performance LMI Affordable Housing Goal Source: Financial Crisis Inquiry Commission
Accounting Scandal Freddie Mac reveals improper management of earnings in 2003. Office of Federal Housing Enterprise Oversight (OFHEO, now FHFA) investigation in 2004 uncovers poor financial accounting and disclosure. Top management in Fannie and Freddie forced out, GSEs agree to implementation of portfolio limits and increased capital requirements. Increased regulation of GSEs will be very evident in changes to structure of the U.S. mortgage market at peak of housing bubble.
Crisis
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 House Prices (19891Q1=100) Homeownership Rate The Housing Bubble House prices started to exceed fundamentals around 2002. Homeownership rate peaked in 2004. Prices peaked in 2006. 160 House Prices and Homeownership 70 140 120 100 80 68 66 64 62 Price-to-Rent (FHFA) Price-to-Income (NAR) Price-to-Rent (S&P/Case-Shiller) Homeownership Rate Source: S&P/Case-Shiller National House Price Index; Federal Housing Finance Agency House National House Price Index; National Association of Realtors; U.S. Bureau of Labor Statistics; U.S. Census Bureau
Share of Home Mortgage Debt Outstanding Price-to-Income Ratio Market Share 80% Share of Home Mortgage Debt Outstanding, 1968-2008 4.0 60% 3.5 40% 3.0 20% 2.5 0% 2.0 1968 1973 1978 1983 1988 1993 1998 2003 2008 Commercial Banks and Thrifts Federal Government and Sponsored Agencies Finance Companies and Private Securities Issuers Other Mortgage Debt Holders Median House Price-to-Family Income Ratio Source: Federal Reserve, Flow of Funds; Historical Statistics of the United States; National Association of Realtors ; Census Bureau
1999Q4 2000Q4 2001Q4 2002Q4 2003Q4 2004Q4 2005Q4 2006Q4 2007Q4 2008Q4 2009Q4 2010Q4 Share of Originations Price-Rent Index Market Share GSE share of originations was inversely proportional to subprime lending and house prices. 100 80 160 140 60 40 20 0 120 100 80 60 GSE New Business Subprime & Alt-A Price-Rent Ratio Notes: House price index is scaled by owners' equivalent rent of residences and indexed to the average of 1987 to 2010 equals 100. Market share calculated as 4-quarter moving totals. Sources: Inside Mortgage Finance; S&P/Case-Shiller National Home Price Index; Bureau of Labor Statistics
2007Q3 2007Q4 2008Q1 2008Q2 2008Q3 2008Q4 Note: CRA delinquency rate taken from a portfolio of CRA loans managed by Self-Help Credit Union. Sources: Mortgage Bankers Association; Fannie Mae; Center for Community Capital 2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 Delinquency Higher risk loans purchased by GSEs have defaulted at half the rate of self-denominated subprime loans in the market. 35% 30% 25% 20% 15% 10% 5% 0% Serious Delinquency Rate Subprime FNMA (FICO<620) FNMA (LTV>90) FHA CRA
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Role Reversal GSE purchased of private-label MBS inverted their traditional role and bypassed quality control. $1,400 Volume of Mortgage-Related Securities, 1997-2009 $1,200 $1,000 $800 $600 Agency Purchases of Private- Label Securities Total Private-Label Security Issuance $400 $200 $0 Source: Federal Housing Finance Agency; Inside Mortgage Finance
Millions Conservatorship September 2008 Initially driven by write-downs on private-label securities Weakness in housing market spreads to single-family book of business 40% of single-family credit losses from Alt-A Fannie Mae Segment Net Income (Loss) $10,000 $0 -$10,000 -$20,000 -$30,000 -$40,000 -$50,000 -$60,000 -$70,000 2006 2007 2008 2009 Source: Fannie Mae SEC filings Single-Family HCD Capital Markets
Bailout By the end of 2011, Treasury had invested $182.7B in GSEs. OMB estimates total investment of $221B but a cumulative cost of only $28B. GSEs were required to pay 10% quarterly dividend on stock purchases. By the end of 2011, $36.3B had been paid back to Treasury in dividends. In August 2012, Treasury altered dividend payment plan to take any and all profits. Fiscal Year 2013 Analytical Perspectives. Office of the Management and Budget
Loan Modifications 1.5M GSE loans refinanced to lower rates through Home Affordable Refinance Program (HARP), including 91K with LTV>125%. 508,600 mortgage payments reduced under Home Affordable Modification Program (HAMP) In July 2012, FHFA Acting Director, Ed DeMarco, said the GSEs would not be allowed to participate in a principal reduction program under HAMP FHFA s own analysis said the program could save the GSEs $3.6B and taxpayers $1B DeMarco was particularly concerned about strategic default.
Reps & Warranties Fannie and Freddie can force banks to repurchase loans if reviews find the underwriting didn t meet Representations and Warranties set out in sales contracts. GSEs asked lenders to buy back $18.9B in mortgages in first six months of 2012 Lenders underwriting even more conservatively than guidelines require to avoid put backs
Reforms
Dodd-Frank Reforms Consumer Financial Protection Bureau Qualified Mortgage ability-to-repay standard full documentation, no negative amortization, no interest only, no balloon, no adjustable interest rates with fixed terms under 5 years, fee restrictions Qualified Residential Mortgage FHFA: debt-to-income (DTI) ratio 28%/36%, 690 FICO score, 80% loan-to-value (LTV) Non-QRM loans require 5% risk retention Excludes purchase of PLS from either the numerator or denominator in calculating housing goal performance
Percent 90+ Days Delinquent or Foreclosed Upon (February 2011) Dodd-Frank Reforms QRM would have only marginally reduced foreclosure rate above what QM alone would have accomplished 16 14 12 10 8 6 4 2 0 Loans Foreclosed by Proposed QRM Guidelines Source: Center for Community Capital
Percent of Loans Excluded Dodd-Frank Reforms QRM would exclude large segments of the market 90 80 70 60 50 40 30 20 10 0 Exclusion from the QRM Market All White Black Hispanic Asian Source: Center for Community Capital
Percent of Loans Excluded Dodd-Frank Reforms QRM would exclude large segments of the market 100 90 80 70 60 50 40 30 20 10 0 Exclusion from the QRM Market All Low Moderate Middle Upper Source: Center for Community Capital
GSE Reform GSEs hold entire credit risk, making non-qrm risk retention effectively irrelevant Officially, deemed to pass February 2011 Treasury white paper laid out three options: 1. Privatized system of housing finance with the government insurance role limited to FHA/VA assistance for narrowly targeted groups of borrowers 2. Privatized system of housing finance with assistance from FHA/VA for narrowly targeted groups of borrowers and a guarantee mechanism to scale up during times of crisis 3. Privatized system of housing finance with FHA/VA assistance for low- and moderate-income borrowers and catastrophic reinsurance behind significant private capital. e.g., federal reinsurance for private mortgage insurers, but notably private mortgage insurance is not accounted for in current QRM definition
GSE Reform [S]ignificant operational challenge in designing and managing an organization that can remain small during normal economic times, yet has the capacity to take on much more business quickly during these times of need. Moral Hazard still an issue What to do with existing loan portfolios and guarantees? In addition to changing dividend structure, Treasury also increased rate at which GSEs must reduce portfolio holdings from 10% to 15% per year. Total assets currently stand at $1.4T.
3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 740 or Higher 720 739 700 719 GSE Reform Risk-Based Pricing vs. Pooled-Risk Pricing Loan-Level Price Adjustments and Adverse Market Delivery Charges 680 699 660 679 640 659 620 639 Under 620 Mar-08 Jun-08 Nov-08 Apr-09 Apr-11 Note: LLPAs are for mortgages with loan-to-value ratios between 75.01% and 80.00%. Source: Fannie Mae