Dennis' Mortgage Blog

On Friday September 2, 2011 the Federal Housing Finance Agency (FHFA)filed suit in federal court against seventeen financial companies. The purpose of the suit was to sue the companies for selling Fannie Mae and Freddie Mac mortgage backed securities that went into default when the housing markets collapsed.

The FHFA is the government agency charged with overseeing Fannie and Freddie, which are now backed by the U.S. Treasury which has covered approximately $165 billion in losses for the two Government Sponsored Entities (GSEs).  Trying to recoup some of the losses FHFA is suing as it feels the lenders misrepresented the mortgages sold to Fannie and Freddie as complying with Fannie and Freddie underwriting guidelines and standards.  Quoting from the announcement, FHFA says the lenders sold mortgages "that significantly overstated the ability of the borrower to repay their mortgage loans."

Some keywords in the above paragraph are underwriting guidelines and standards and overstated.

In the early 2000s Fannie and Freddie both shifted nearly all of the underwriting decisions for loans they would purchase from lenders from humans to their Automated Underwriting Systems (AUS).  Each GSE developed their own AUS, for Fannie Mae the AUS is Desktop Underwriter or Originator and for Freddie Mac it is Loan Prospector.  The AUS software enables loan originators, people like me, to upload a mortgage application to either Fannie or Freddie and receive underwriting results approving or declining the mortgage as submitted. 

If approved the AUS gives the evidence required to document the mortgage application.  During the expansion of the housing bubble the underwriting guidelines and standards for Fannie Mae and Freddie Mac became almost nonexistent. 

It was routine for borrowers with credit scores over 680 to receive AUS approvals for debt-to-income ratios up to 60%, that means that before any paycheck deductions and excluding any payments for utilities, food, clothing, etc, the GSE software would approve a mortgage for a borrower whose combined credit payments and new housing payment was 60% of their gross income.  Even with a tax deduction for homeownership it leaves the borrower only 40% to pay state and federal taxes, social security, health insurance, food, clothing, child care, etc. 

Regarding "overstating the ability of the borrower to repay their mortgages" it became unique if the AUS findings required any income verification for the borrower.  Whatever income was put on the loan application was generally accepted by the AUS, and therefore Fannie and Freddie, and the only verification needed was a phone call to the employer to verify the borrower worked there, if self-employed all that was needed was a letter from a tax preparer saying the borrower had self-employed income on their tax returns the prior two years.  No paychecks, no W2s, no tax returns to see if they self-employed borrower actually made a profit from the business income.

As well for most purchase transactions the AUS would not require any asset verification either, just bring the money to escrow for closing.

Finally more often than not for most of the transactions in Southern California headed to Fannie or Freddie there was no appraisal required either, or if there was it would be  a drive-by inspection by the appraiser to ensure the property existed without any comparable sales or detailed viewing of the property.

The primary reason for these underwriting decisions were most of the Fannie Mae and Freddie Mac mortgages were applications for loans that were 80% loan to value or less so there was no mortgage insurance requirement.  Was everyone putting 20% down? Hardly, most borrowers during this period had second mortgages that lowered the primary mortgage to 80% loan to value.  How big were the second mortgages? Many were 10% but most were 20%, meaning there was no money down and the property was 100% financed. 

The result was billions of dollars in mortgages to Fannie Mae and Freddie Mac in which the borrower was putting no money down on a purchase, or refinancing to 80% loan to value or higher if they were adding a second mortgage.  Billions of dollars of mortgages on highly or fully leveraged properties approved under Fannie and Freddie underwriting guidelines that required no income, no asset and no property value verification.

FHFA's lawsuit is misdirected in my opinion.  Instead of suing the lenders who followed the guidelines and policies established by Fannie Mae and Freddie Mac, and who followed the documentation requirements provided by Fannie and Freddie's Automated Underwriting Systems, they should be suing and filing charges against the Fannie and Freddie administrators who loosened the underwriting guidelines that turned the bulk of Fannie and Freddie securities into high risk, subprime mortgage investments.

I am waiting for a major investor who has lost significant capital on Fannie and/or Freddie Mortgage Backed Securities from the housing bubble period to sue Fannie and Freddie for their lax underwriting requirements allowing stated income, asset and property values on mortgages that Fannie and Freddie then graded as A-mortgage paper and sold on the market.  The pretrial investigations and depositions could include members of Congress who pressured the GSEs to loosen credit requirements for mortgages to promote and increase home ownership.

The FHFA lawsuit is unfounded in my opinion, for the most part the lenders sold loans to Fannie and Freddie that contained the minimum documentation required for purchase according to the underwriting guidelines and policies provided by Fannie and Freddie.

Unfortunately the result of this lawsuit being filed will be further tightening of credit and increased overlays for mortgage applicants.  This will result in fewer mortgage approvals and have a negative impact on housing markets still struggling across the country.

Rates are at all time lows, call me to lower your mortgage payment or to get pre-approved to buy your new home.