A single GSE eliminates competition between automated underwriting systems mitigates risk and ensures sound mortgage lending decisions are made—if a recent plan from the FHFA comes to fruition.
According to a Federal Housing Finance Agency proposal, the agency will wind down the activities and combine the back offices of Fannie Mae and Freddie Mac over a five-year period through the creation of a single GSE.
In a monolithic GSE world, automated underwriting exists without the hyper-competitive environment that marked competition between Fannie Mae and Freddie Mac.
The incentive to compete by lowering lending standards and reducing documentation standards is eliminated. The technology will continue to issue fast decisions—and more importantly better decisions.
But, almost by definition, the one GSE suppresses creativity and stifles innovation, two consequences that are neither the preferred bedfellows of financial markets—nor free market devotees of the Reagan variety.
In the mortgage market, however, these consequences are a worthy goal, a necessary evil the industry will have to learn to live with. That’s because it serves to clamp down on the risk mania that punctuated the bubble years.
In the run-up to the collapse, credit and documentation standards were lowered, but the infamous black boxes—Loan Prospector and Desktop Underwriter—continued to stamp loans with their imprimaturs.
Happy borrowers moved into their homes. Successful lenders earned their fees. Savvy investors made their bets (beds) and generated—in the short term at least—huge profits for their firms.
The GSEs believed they understood the risks their adventures in subprime lending exposed them to and had hedged them effectively. Meanwhile, clearer thinking alternative investors shorted the market, and waited for the financial melt down they knew would occur.
Fannie Mae and Freddie Mac focused on preserving, protecting and expanding their market shares—but that required innovation and a willingness to fund the subprime market run-up.
Over time, competition led to a breathless reduction in the lending standards, and reduced documentation requirements. Automated underwriting made approvals easy and supported an unlimited volume of loans.
At mortgage conferences, panelists made the case for the “document-free mortgage movement” with an apocryphal story—that set the table for the mortgage bubble: Getting a mortgage should be as easy as buying a new Mercedes-Benz.
They reasoned that a Mercedes was a large investment that did not require the documentation that a mortgage required, yet it lost half its value the minute it was driven off the lot.
In contrast, a home was an appreciating asset—and yet required dozens of documents and a couple months to complete the transaction.
Some of those documents, they reasoned, could be removed from the process without any additional risk to the lender. Borrowers’ downpayments were large enough to guarantee they would pay their mortgages—no matter what economic catastrophe they faced.
No one, however, suggested that getting a car loan should be made more difficult, rather than relaxing standards on mortgage originations.
To be sure, subprime mortgages had been around for years, but they comprised a small fraction of the loans that were made. But that changed when credit standards were reduced to ensure that congressionally imposed homeownership goals for low-income and minority borrowers were met.
In fact, by 2007 almost 50% of mortgages originations were subprime and alternative-A types with Fannie Mae, Freddie Mac and other agencies guaranteeing about 70% of them, according to Edward Pinto of the American Enterprise Institute.
Competition made getting a mortgage so fast, so easy, so efficient, so inexpensive, that virtually anyone who could sign his name could get one—and many did. The FHFA has acted to ensure that never happens again.
Matt Strickberger is the managing partner of OnPoint PR and Consulting LLC, a public relations firm that represents lenders, servicers, technology companies and others. He was editor of Mortgage Technology magazine from 1997-2000. If you have comments or suggestions for future columns, email him at mstrickberger@onpoint-pr.com.
