It was encouraging to see the FHFA take this first important step in defining repurchase exposure and responsibility, albeit, beginning in 2013. This indication of reasonability is critical if we are to correct the lagging purchase market.
Thousands of worthy borrowers are being denied credit, based upon overly tight underwriting standards and FICO scores driven by repurchase fears. Mortgage banking is no longer an industry utilizing a half-century of accumulated underwriting knowledge to make a credit decision. Instead, now the emphasis is on creating the “perfect loan.”
We know that real estate generally leads into and out of all recessions and recoveries so we must address this segment of the business and make it a priority if the economy is to sustain any long-term growth and healthy job creation returns to our country. Not surprisingly, the real estate industry—construction, sales, finance, manufacturing, etc.—has the largest job creation factor of all industries which underscores its importance to the overall economic recovery.
For 40 years Fannie Mae and Freddie Mac were the envy of the financial world, the leading example for countries to emulate as they planned their mortgage finance models. Fannie and Freddie had a simple mission: To insure liquidity in the residential and multifamily mortgage market, thereby assisting the overall economy and helping people achieve the American dream.
The concept was both brilliant and simple. With an imputed guarantee backed by the United States, they would buy loans created by approved lenders, place them in pools and sell these securities around the world.
As stated, this concept worked well until we made a fatal mistake in judgment. We allowed the GSEs to become publicly traded companies, changing their fiduciary responsibility from one of “mission” to one of “creating of shareholder value,” from providing liquidity and serving the market to one of stock price, bonus opportunities and stock option grants.
What happened? The question then became how to serve two different worlds, continue to provide liquidity, meet housing goals and, at the same time, continue to grow and sustain earnings at record levels. One of the answers was to develop a separate portfolio of loans which was developed to earn a large spread between the GSEs’ borrowing cost (close to the U.S. Treasury) and the mortgages in this separate portfolio. Obviously, the higher risk behind the loan, the higher yield it produced, resulting in the greatest profit. Why else would the GSEs buy subprime and stated income loans and place them in their investment portfolios?
My contention is that had the GSEs not gone public, adhered to their original mission and only purchased conforming, fully underwritten mortgage product, they would have fared significantly better throughout the recessionary cycle and saved taxpayers hundreds of billions of dollars. Because of their performance, they became an easy political target for regulators and legislators who recommended change and demanded a new approach, openly advocating that we shutter these “out of control giants.”
The problem is that no better system exists in today’s environment. Given their current posture, reporting through FHFA, profits going to Treasury and no investment portfolio, they are perfectly structured and back to fulfilling their intended mission, insuring mortgage liquidity. One could argue this is a far better alternative than creating five privately held mini-GSEs who would be hard to regulate, controlled by shareholders and susceptible to the same mistakes evidenced by their larger publicly traded models.
Also of interest is the question: If these mini-GSEs fail, who bails them out this time around? Let’s be realistic here. It’s the same hard-pressed American taxpayer who footed the bill for Fannie and Freddie. Why? The answer is simple: Because American real estate is too important to the overall state of the U.S. economy and the world’s financial systems. There is only one entity large enough to correct a failure of this magnitude. No bank, no insurance company, no corporation is financially capable. Only the American taxpayer can underwrite a failed GSE or two, or five!
We have a model that works. It will be easy to increase fees moderately as the securities market returns to health, allowing the private sector to assume much of the risk. Then decrease fees as liquidity is needed, purchasing a larger market share to help the real estate market and general economy get through a difficult cycle.
The answer does not necessitate new approaches, new unquantifiable risks, and new models. It simply requires the GSEs stick to their knitting as they did for 40 years and if allowed to function properly they again will become the model all modern countries aspire to create.