Freddie And Fannie Reform – The Monster Has Arrived

Submitted by Ramsey Su via The Acting Man blog,

Legal Mumbo-Jumbo

As promised, the Johnson/Crapo bill has finally arrived. Here are the 442 pages of legal mumbo jumbo, guaranteed to cure all forms of insomnia and those suffering from low blood pressure.

Allow me to provide a summary.

The Bill calls for the elimination of FNMA and FHLMC. It will be replaced by FMIC with a 5 member board appointed by the president. There will be a 9 member advisory board to assist FMIC and the OCMA. An internal OIG will be funded by the FMIC to inspect the FMIC. The FMIC and the OCMA would update Congress on the MIF and audited by the Comptroller General. FMIC can create any office but must establish the Office of Underwriting, Office of Securitization and the Office of Federal Home Loan Bank Supervision. The OCMA would administer the Market Access Fund. Of course, we cannot forget multifamily housing. There will be an Office of Multifamily Housing. As for regulations, FMIC starts with the Standard Form Credit Risk-Sharing Mechanism. Then there will be rules for the Mortgage Insurance Fund. FMIC would be exempt from SEC but there will be a Securitization Platform with a Platform Board. Regulations to come include servicers, IDI, PMI and the authority to issue any regulation they desire ……… I am sorry, I need to stop here, I can't read any more. My head is hurting too much, trying to compute the compliance cost. (MND has a good summary for those interested.)

House Price Inflation and the Fed

Instead of wasting time on the details, I would like to approach Freddie and Fannie reform from a different perspective – the origination and loss recovery.

In hindsight, it is clear that the agencies did not lead the sub-prime bubble but they were nevertheless dragged into the cesspool. They never provided no-doc no-qualification NINJA loans, but cannot escape the simple maths of lending 95% LTV loans when the V (value) was artificially inflated by 40%-50%-or more, resulting in all the negative equity loans outstanding today. Regardless of how qualified a buyer may appear to be at origination, if the property's value declines by, say 20%, all 95% LTV loans will be in trouble.

Is double digit home price appreciation a reasonable expectation, when inflation (as imagined by the Fed) is non-existent, income growth is negligible and GDP growth is barely a couple of percent? Is the bill going to prevent the new agency from insuring loans secured by inflated assets?

It is unclear how the Fed justifies buying agency MBS when home prices are appreciating at an unsustainable pace and agency loans command 90% of the mortgage market. Are they trying to use a housing bubble to rescue the economy? Are the Fed's actions disregarding any consequences to the real estate market? Is the purchase of agency MBS a real tool for monetary policy, or is it just something the Feds were allowed to do?

Greenspan, Bernanke and Yellen all confessed that they were wrong about sub-prime. They all underestimated the consequences. Yet, they are still empowered to openly manipulate the real estate market, something they admitted that they know very little about. For agency reforms to be meaningful, Congress should first remove the power of the Fed to buy agency MBS, allowing some type of orderly free market price setting mechanism to return.

Making Rules Up on the Fly

As regards loss recovery, there were Federal Laws, State Laws and local government ordinances, the rules and procedures that a lender must go through when a borrower defaults on a mortgage. They have all been ignored during the aftermath of the sub-prime bubble. Order has not been restored. No one can really say what the rules will be if the industry suffers another down turn. The Johnson/Crapo Bill adds to the confusion:

Sec.305. Authority to protect taxpayers in unusual and exigent market conditions.

If the Corporation, the Chairman of the Federal Reserve Board of Governors and the Secretary of the Treasury, in consultation with the Secretary of Housing and Urban Development, determine that unusual and exigent circumstances threaten mortgage credit availability within the U.S. housing market, FMIC may provide insurance on covered securities that do not meet the requirements under section 302 including those for first loss position of private market holders.

In other words, Section 305 explicitly states that if the Fed, the Treasury and HUD decide market conditions are "unusual and exigent", whatever that means, they can have taxpayers directly fund any bailout and change the rules as they see fit. To have the gall to say they are protecting taxpayers is an insult to the intelligence of the taxpayers. Hmmmm. "Intelligence of the taxpayers"? I need to think about that one.

How can risk managers assess mortgage risk when the rules are moving targets, subject to changes that are dependent upon the prevailing political winds?

The agencies have been providing cheap financing to borrowers, courtesy of the Fed. The agencies have been providing cheap and bullet proof insurance for bond investors, courtesy of the Treasury. The Bill somehow expects some mysterious private capital will come in to insure the first loss position and the Government (including the FOMC) can gracefully exit its role in the mortgage monopoly. That is more than overly optimistic. Can anyone quantify that in dollars as well as mortgage rates?

Conclusion:

In summary, the Bill is going to increase mortgage compliance costs. It will confuse, rather than clarify, the mortgage application and approval process. It is a disaster. Fortunately, I opine the Bill has no chance of passing in its present form.

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