Edition #7: Gouging the Addicts

April 20, 2020|GSEs, Mortgage Industry, Repurchases, Virus Response

FHFA Changed the Deal in the Crisis

When this virus quarantining is done, I might have to spend an entire Musings devoted to the bourbons and martinis that helped me survive-or my Peloton. The Spring conference season should be in full swing. "Zoom" happy hours are a poor substitute for the in-person real thing, but much better than nothing. I miss everyone.

For now, however, I’ve got some serious accusations to level.

Mortgage Bankers are Addicts

First of all, I’ve said it before, the opioid crisis is a metaphor for the mortgage banking industry’s relationship with the financing provided by the government sponsored agencies (Fannie, Freddie, FHLB’s and even FHA). You could say the government got the mortgage industry (including many banks) “hooked” on originating non-recourse mortgage financing to help ease the “pain” of the nation’s housing industry and allow greater (and cheaper) mortgage financing for the whole country. The policy logic for this is that homeownership makes better citizens and builds wealth, so government financial support of housing enables better lives for all Americans. Yes, the industry got addicted to cheap, non-recourse 30-year financing, but so did the whole residential real estate industry and homebuyers as well.

So, now, many of the addicts need a “fix”, except FHFA Director, Mark Calabria, is playing the role of Nancy’s parents from the movie Sid and Nancy where Sid Vicious (of the Sex Pistols) played by a young Gary Oldham) and his girlfriend Nancy call Nancy’s parents to get money. Nancy, crying on the ground, blubbers, “they wouldn’t give us any money, they say we will spend it all on drugs”, to which Sid replies, “Well, we would.”.

GSEs Should Be Viewed as Utilities

As much as Director Calabria would like to privatize Fannie and Freddie, the “G” in GSE still stands for government and with no other buyers of US mortgage loans today, the GSEs are the only game in town. When no other market exists, they are and should be treated like a mortgage utility and FHFA is a federal regulator, not a liquidator. The cardinal rule of any regulator should be like the Hyppocratic Oath’s “first, do no harm”, but Director Calabria appears to be still playing by the same playbook he had prior to the virus. His playbook still puts privatization as his primary goal.

The Federal Reserve, on the other hand, understands its role and has flooded the financial markets with liquidity to keep the system from seizing and spiraling into worse shape. Normally, the Fed would be concerned about inflation in making money so readily available, but they have realized that inflation is a much lesser concern today than sending the entire economy into a depression. FHFA, on the other hand, appears to be seizing this moment to further its privatization objectives, one which may result in uncertain consequences at perhaps the worst possible time.

The FHFA and GSEs are Gouging

That heading is quite an accusation, but I’ll explain. The GSEs are still buying loans, but, in the midst of a pandemic, they have basically changed the non-recourse deal by allowing borrowers to get forbearance just for asking. Servicers are upset they have to front the payments and some don't have the liquidity to do that. Contractually, however, the risk of loss from that consumer accommodation could be passed back to the origination industry due to the representations and warranties made tothe GSEs on sale. The GSEs contracts of adhesion have not been changed.

Imagine if an electric, gas or water utility said to its customers, “we’ll still sell you our electricity/gas/water at the same price, but you’ve got to fix the lines if they break”. Sure, you could try to build a beautiful new off-grid, “green” house like these guys, but in the middle of a pandemic? Is this really the time to wean the addicts off the drugs and see how a new system of mortgage finance would work in the US?

Like Toilet Paper Sellers

As the only home loan buyers, the GSEs are using their market power to gouge the sellers, not on price, but on the terms. To use another timely analogy, the GSEs have unlimited toilet paper, but you might have to take it back when they are done with it. Yuck. In the face of unprecedented quarantining and economic shutdown, Director Calabria and the GSEs are basically saying to the mortgage industry and, by extension, the entire American real estate market. “Go ahead, keep making loans, but don’t give us any new loans that use the forbearance we offer or we are going to have the right to come back to you for any losses for the life of the loan.” So much for non-recourse sales.

[Updated April 23, 2020] On April, 22, the FHFA announced the GSE could buy certain loans in forbearance, but would charge originators 5% of the loan amount for first time homebuyer loans and 7% for rate & term refinances (cash-out still not permitted). These are massive risk premiums that bear little relationship to the actual risk of loss (e.g., why would first time homebuyers be a lower risk?), but more designed to discourage sale of forbearance loans except to the most desperate of sellers (again, the virus, along with the monopolistic market power of the GSEs and the forbearance program FHFA instituted are causing the desperation). If those loans perform after the forbearance, the FHFA isn't going to give the originators back the risk premium nor will they release the originators from other life of loan recourse claims. This development, heralded by FHFA's press release "to keep lending flowing" only further makes the FHFA appear to be shameless in its gouging of the mortgage industry.

[Updated August 13, 2020] On August 12, 2020, Fannie Mae and Freddie Mac announced a 50 bp price increase on most refinances. Certainly, that does nothing to help homeowners during the pandemic, but it may further the FHFA's objectives in terms of limiting the scope of the GSEs and in improving their profitability and capital structures. The GSEs claimed the fee was necessary to address “risk management and loss forecasting resulting from COVID-19 related economic and market uncertainty.” I'm not sure what that even means now that we're about 6 months into this pandemic, so I question that excuse (and so does the MBA). Unfortunately, I do not expect FHFA/GSEs will ever reverse this surprise policy.

See You in Court

I negotiated and argued dozens of repurchase claims coming out of the “meltdown”. In that period, the industry could be blamed for reckless underwriting, unaffordable lending products and poor servicing. This time, however, we can clearly blame a virus, government action in response and specifically the GSE mortgage utilities who imposed a moral hazard without accepting the consequences. While we don’t know if the GSEs will seek to use that contractual recourse against originators in the months and years to come (or the extent of losses, if any), originators will be armed with a variety of legal and equitable arguments for the judicial process to sort out in hindsight.