Of all the people who’ve played a role in the housing bubble and its aftermath, the one who continually impresses me is Edward DeMarco, conservator for the GSEs. He is a career bureaocrat who was placed in charge of the GSEs when they were taken into conservatorship in 2008. He has steadfastly protected the interests of taxpayers much to the chagrin of politicians on both the left and the right. The left hates him because he refuses to give loanowners free money through principal reductions. The politicians on the right who’ve sold their souls to banking interests don’t like him because he pursues buyback claims against the major lenders who underwrote shoddy loans. The one commonality in all his decisions has been protecting the interests of taxpayers and preventing the GSEs from becoming a cash cow politicians can loot for their political constituents.
From DeMarco’s actions, it’s clear that he really understands the current role the GSEs play in the housing market, and he has a vision for how they should be scaled down and ultimately eliminated.
* Could lead to closing of Fannie, Freddie
* Fannie, Freddie to abandon current securitization systems
* New company could be privatized or merged into government
WASHINGTON, March 4 (Reuters) – Fannie Mae and Freddie Mac will form a joint venture for securitizing home loans that could end up replacing the two government-controlled mortgage finance giants, their regulator said on Monday.
“The overarching goal is to create something of value that could either be sold or used by policymakers as a foundational element of the mortgage market of the future,” Edward DeMarco, acting director of the Federal Housing Finance Agency, told the National Association for Business Economics.
Some level of government support will likely always be with us. Even if we eliminated all government programs, if the market got in trouble again, political pressures from both sides would result in government creating a new one to respond to the crisis. Like the false promises of no government backing for the GSEs, any promises to stay out of the housing market would be broken at the first sign of trouble.
The FHA has been around since the Great Depression, and it has served as a lender of last resort when other credit sources evaporate. Despite the huge losses being racked up at the FHA, it’s widely considered a successful program as a lender of last resort. It’s market share shrinks when times are good and grows when times are tough. That’s how an emergency backstop should work.
Given that some form of government backstop will always be in place, the question becomes how do we structure it.
When the GSEs were formed in the late 60s and early 70s, the government’s intent was to create a more vibrant secondary mortgage money to improve the distribution of capital across the country. Prior to the GSEs formation, it was common for banks to be short on available capital in hot markets while money sat idle in slow markets (we didn’t have the too-big-to-fail behemoths back then). The secondary mortgage market allowed the capital to more easily flow to where it was most needed.
The government chose not to expand the role of the FHA at the time the GSEs were formed. Increasing the size and scope of a government bureaucracy is never popular, and the hybrid government-private solution was a compromise that avoided expanding the role of government directly. The only reasons two entities, Fannie Mae and Freddie Mac, were formed is because the government wanted to see competition between the two in order to keep costs down and operational efficiencies high. Creating a monopoly would have been a worse solution. Obviously, the idea failed. No matter how much politicians denied the implicit backing of the GSEs, it was always there. And without proper government oversight, the taxpayers were exposed to enormous liabilities as the supposedly private institutions took on excessive risks to chase profits. The result was the conservatorship of 2008.
Fannie Mae and Freddie Mac, which help finance about two-thirds of new U.S. homes loans, were seized by the government in 2008 as mortgage losses mounted. They have drawn nearly $190 billion from the U.S. Treasury to stay afloat.
DeMarco said the goal was to build a single infrastructure to support the mortgage credit business that could be privatized, merged into the government or function as a utility. The two companies would have to abandon their separate systems.
“We are on a path to replace the outdated proprietary operational systems of Fannie and Freddie,” DeMarco told reporters on a conference call ahead of his speech. “It could be turned to some form of a market utility.”
This is a brilliant move. We no longer need two entities now that these are not competing private companies. By consolidating their functions, DeMarco is creating a bureaucracy and function similar to the FHA. This gives the government the options to later (1) merge this entity with the FHA, (2) keep it as a separate insurance entity, or (3) sell it to the private market as an insurance company. Each option has its pluses and minuses, and Congress will have to chose which way to go. Creating this new infrastructure is a necessary first step.
Further, once the insurance and securitization function is separated from the two companies, what’s left over are two holding companies with vast portfolios of mortgages. These holding companies could be (1) sold as a business unit to the private sector, (2) the securities could be sold individually to the private sector, or (3) the entities could be slowly allowed to die as mortgages are paid off and no new mortgages are added.
Democrats and Republicans on Capitol Hill agree that Fannie Mae and Freddie Mac should eventually be wound down, but have failed to find common ground on what should replace them. DeMarco’s plan provides an interim structure for some of their business, but the ultimate decision remains in Congress’ hands.
The new company will be structured as a joint venture that is owned by Fannie Mae and Freddie Mac, DeMarco told reporters as he laid out FHFA’s plans for 2013.
He said the new venture was not expected to begin securitizing loans this year. Instead, the focus will be on creating the business and hiring staff. The company will have its own chief executive and board.
“It can achieve some economies of scale to hopefully reduce the cost to the taxpayers,” said Mark Calabria, director of financial regulation studies at the Cato Institute. DeMarco “is trying merge the two companies, lay the groundwork for something different and ultimately nudge Congress to work on reform.” …
And DeMarco’s actions should prompt Congress to act. By moving forward the way he has, he can make some decisions for Congress that they may not want to make on their own. His actions provide political cover for what might otherwise be unpopular decisions. Over time, the momentum DeMarco is creating will push Congress toward the options I outlined above.
DeMarco also said Fannie Mae and Freddie Mac would have to shrink their multifamily home loan business by 10 percent.In addition, they will have to try and complete transactions that do not rely on a full government backstop. FHFA will require the companies to sell at least $30 billion in mortgage-backed securities in 2013 in which the private sector would bear some of the risk of losses.
“What we’re looking for is to have some portion of the risk sold off to private owners and that way reduce the exposure of the taxpayer,” DeMarco said.
The companies will also be required to reduce the less liquid portion of their mortgage portfolios by 5 percent next year on top of an existing mandate that requires them to shrink their overall portfolios by 15 percent each year.
The rate of liquidations could increase once the entities become holding companies. Everyone will soon realize the government has no need to own mortgage holding companies, and liquidation is a relatively easy task.
Even though the loans they have backed recently are performing well, DeMarco noted that the market was still “reliant on federal support, with very little private capital standing in front of the federal government’s risk exposure.”
The truth is that private lending is simply not willing to underwrite loans at current interest rates without government backing. The jumbo market demonstrates where private money feels comfortable. Currently, the premium for a jumbo loan is about 0.25%, and lenders are only willing to make loans with such a low premium spread if the down payments are 25% or more. Any reduction in the support from the GSEs transitioning to a private market will drive up interest rates and increase down payment requirements, something that will not help reflate the housing bubble and restore collateral behind the $1 trillion in unsecured mortgage debt held by the banks.
DeMarco is doing the right things to protect the US taxpayer, and the framework he is putting in place gives politicians viable options for winding down the GSEs while maintaining some level of government support for the housing market.
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Proprietary OC Housing News home purchase analysis
$719,900 …….. Asking Price
$1,038,000 ………. Purchase Price
11/4/2005 ………. Purchase Date
($318,100) ………. Gross Gain (Loss)
($57,592) ………… Commissions and Costs at 8%
($375,692) ………. Net Gain (Loss)
-30.6% ………. Gross Percent Change
-36.2% ………. Net Percent Change
-4.8% ………… Annual Appreciation
Cost of Home Ownership
$719,900 …….. Asking Price
$143,980 ………… 20% Down Conventional
3.56% …………. Mortgage Interest Rate
30 ……………… Number of Years
$575,920 …….. Mortgage
$131,975 ………. Income Requirement
$2,605 ………… Monthly Mortgage Payment
$624 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$180 ………… Homeowners Insurance at 0.3%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$3,409 ………. Monthly Cash Outlays
($408) ………. Tax Savings
($897) ………. Equity Hidden in Payment
$165 ………….. Lost Income to Down Payment
$200 ………….. Maintenance and Replacement Reserves
$2,469 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$8,699 ………… Furnishing and Move In at 1% + $1,500
$8,699 ………… Closing Costs at 1% + $1,500
$5,759 ………… Interest Points
$143,980 ………… Down Payment
$167,137 ………. Total Cash Costs
$37,800 ………. Emergency Cash Reserves
$204,937 ………. Total Savings Needed