Dennis' Mortgage Blog

Question of the week:  What are your thoughts on the proposal by the Obama Administration last Friday regarding Fannie Mae and Freddie Mac?

Answer:  My thoughts are that it made news for one day and given the nature of the proposal nothing will come of it. 

Some background.  Fannie Mae and Freddie Mac are “Government Sponsored Entities”, or they were when chartered to be secondary markets for mortgages; if you see the letters GSE think Fannie Mae and Freddie Mac.  Congress can, and has, influence the GSEs and their underwriting standards, loan limits, charges to lenders, and who should be able to qualify for mortgages and purchase new homes.  In 1977 Congress passed the Community Reinvestment Act, CRA, to encourage lenders to increase investment in local communities and expand homeownership.  Until the mid-1990’s the CRA was mostly geared to commercial and business lending and investment.  Starting in the mid-1990’s Congress became more insistent on expanding homeownership as part of “affordable housing” and pressured the GSEs to use CRA to expand qualifying ratios and underwriting guidelines to expand homeownership.

The U.S. residential mortgage market is about $10.6 Trillion.  Since the U.S. Treasury put Fannie Mae and Freddie Mac into conservatorship in 2008 they have cost U.S. taxpayers $134 billion.  Fannie and Freddie are responsible for about 70% of the current residential mortgage market (FHA is about 20%).  The losses that make up the $134 billion are mostly due to mortgages funded before the Treasury stepped in.

Prior to the loosening of underwriting guidelines to meet Congress’ CRA demands Fannie and Freddie operated very well and profitably.  With the relaxing of guidelines and large drop in interest rates the housing bubble was created and erupted.  The inevitable collapse resulted in foreclosures across the country and homeowners in negative equity positions.  Not surprisingly Fannie and Freddie mortgages being the overwhelming majority of the mortgage markets for decades have taken the brunt of the foreclosure costs.

As a result politicians, pundits, coffee shop experts and government regulators have targeted the GSEs as something that have to go.  Last Friday’s proposal from the White House is the first salvo in what will be many.

In short the White House proposal consists of three options, and the proposal is for phase out of Fannie and Freddie over five to seven years, given their size any total dismantling will most likely take at least a decade.

Option 1:  Greatly restrict loan criteria for Fannie and Freddie mortgages.  Reduce the maximum loan limits.  Increase minimum down payments to 10%.  Increase fees the GSEs charge lenders who sell mortgages to them.  Along with this the option calls for higher insurance premiums for FHA mortgages.  The intention of this option will be to push more borrowers into privately funded mortgages and FHA.  These will result in higher costs for borrowers and lower homeownership.  The latter, lower homeownership, is becoming a more popular theme for many elected officials.

Option 2:  Establish private market for the trading of mortgages that gets government backing when private lenders leave the market during periods of “financial shocks.”  This option would require some type of trigger where the government backstops private lenders to ensure the ability for mortgages to continue to be funded during whatever will be defined as a “financial shock.”

Option 3:  Create new companies to buy mortgages and sell them as securities guaranteed by the government as long as they meet certain criteria and a fee is paid to the government.

My view on the options:

Option 1:  This process already appears underway except instead of restricting Fannie and Freddie government regulators from the Federal Reserve and HUD are creating regulations that are restricting and constricting the mortgage industry and raising costs to borrowers, thereby reducing home ownership.  With this option the role of FHA will greatly increase as its market share will increase.

Option 2:  Essentially this option creates what were the jumbo and sub-prime markets of the 2000’s and the federal government acts as the FDIC.  The jumbo and non-GSE sub-prime mortgages were funded by banks, sold to investment houses who then sold them as securities and derivatives.  When the major brokerage houses were teetering on collapse the government stepped in and used TARP funds to save them or pressured other financial institutions to purchase the failing ones.  Option 2 seems to recreate this market.

Option 3:  This option appears to tear down the current Fannie Mae and Freddie Mac and establish the original models.

The stated intention of the White House is to greatly reduce the role of government in the mortgage markets.  While stating its intent to decrease the role of government in the mortgage market government agencies are vastly increase their role in the mortgage markets.  Each of these options appears to not decrease federal involvement and in some way recreate what was in existence prior to the passage of the Community Redevelopment Act of 1977.

My opinion?  Put a stop loss on Fannie Mae and Freddie Mac. Like with GM put them on the market and recapitalize them as private companies.  Get Congress out of the business of mandating who should and should not get mortgages and eliminate the CRA mandates on Fannie and Freddie and let the markets determine risk, determine returns and determine qualifying guidelines.  Fannie and Freddie can make their own agreements with lenders as to “skin in the game” and loan loss guarantees.  This alone will tighten lending guidelines, as we have already seen.

Since 2008 we have seen a tightening of underwriting standards that have resulted in the highest overall quality of mortgages approved and funded that I have seen since pre-2000 and the introduction of the Automated Underwriting Systems that coincided with tremendous loosening of lending guidelines.  Let this market continue, let the housing markets recover and watch how the GSEs become profitable and once again become a safe conduit for mortgage backed securities.

If your intention is to reduce the role of the federal government in the mortgage markets President Obama then begin by reducing the role of the federal government in the current mortgage markets and rein in the Federal Reserve, HUD and the myriad of other agencies who are imposing new regulations that will cripple the mortgage and housing markets.

Have a question for me?  Ask me!

Inflation numbers for January came out this week and they show the challenges for 2011 for retailers and our economy.  On Wednesday the Producer Price Index was released.  This index shows the cost of goods for manufacturers, those who make what are known as finished products.  The overall index for January was up 0.8% from December, December’s index was up 0.9% from November and the January increase was the seventh month in a row the index rose.  Stripping out energy and food costs and the index climbed 0.5%, the highest increase in two years.  Year to year the index is up 3.6%. 

Consumer prices also rose.  On Thursday the Consumer Price Index for January was released and it showed a 0.2% increase from December.  Year to year the CPI rose 1.0%, which is still well below the Federal Reserve target inflation rate of 2.0%.  In January energy prices rose 2.1%.  Compared to manufacturers consumers are getting a pretty good deal at the cash register.  But for how long?

At some point costs must pass through to consumers.  If manufacturers are paying more for the material to make their widgets they must charge retailers more to purchase the widgets or go out of business.  Having paid more for the widgets the retailers must charge consumers more to buy the widgets in the mall or they will go out of business.  Consumers, as we have seen over the past few years, are highly attuned to bargains, sales, rebates and credits and have been reluctant to purchase anything at full retail cost without incentives. 

What happens if/when manufacturers raise their prices to retailers who raise their prices to consumers and consumers do not buy?  Keep in mind much of the manufacturing is being done overseas, or the raw materials for the manufacturing are coming from overseas.  What happens when the end of the chain, the consumer, refuses to buy because the cost is too high? 

With unemployment still high, and with reports indicating no drop is on the horizon, such as Thursday’s unemployment claims increasing back above the 400,000 mark to 425,000 initial claims filed last week and 3.9 million Americans on continuing unemployment insurance, can the American consumer pay more at the register? 

The next few months will be very interesting in a perverse sort of interesting.  We have the Federal Reserve committed to keeping rates low and pumping money into the economy.  We have the stock markets jumping because of the extra money.  We have commodity prices and energy prices rising quickly.  We have tremendous pressures for inflation to jump up prices for food, clothing and other necessities.  And we have over 14 million unemployed workers who need a job.  If rising prices reduce sales that reduce profits that lead to closings what happens to our unemployment rates and what happens to businesses and workers back down the supply chain all the way to the copper mines and textile companies overseas?

Rates for Friday February 18, 2011 Rates have been getting some downward pressure due to the continuing labor market issues and investors moving to safer investments with the turmoil in several Middle Eastern countries.  Pre-holiday weekend a lot of investors moving out of bonds and to cash and some stocks (markets barely positive).  Third week in a row of no Friday to Friday change in rates in indicates market ready to break out, either up or down.  The past several months mortgage rates have followed a three or four week no-change period with three to four weeks of either declining or increasing rates.  Which will it be?  Some analysts are feeling we are due for a minor rate correction and a downturn following the current period of stability.  Me? I’m chicken and don’t gamble with rates and payments, I say lock if you can.

FIXED RATE MORTGAGES AT COST OF 1 POINT*

30 year conventional                             4.875%             No change

30 year conforming-jumbo                    5.125%             No change

30 year FHA                                         4.75% **          No change

30 year FHA jumbo                              4.75%               No change

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. 

*Please note that rates quoted are based on average of several lenders for a purchase transaction with 20% down payment with an impound account for taxes and insurance and a minimum FICO score of 740; APR is not quoted as it is dependent upon specific loan amounts, lenders and services selected.  Numbers provided are for comparative purposes only.

**The FHA pricing is skewed, to go below the 4.75% would cost more than 1 point, at the rate listed points considerably less, call for quote.

We will be enjoying an extended President’s Day weekend visiting the grandparents in San Francisco as we celebrate our youngest’s birthday.  I hope your weekend is as enjoyable as ours!

Have a great week,

Dennis