Why the FHFA's latest move undermines the MBS market
One of the hallmarks of the current age of pandemic is the degree of volatility moving through the world of business and finance. Both the speed and magnitude of change in perceived risk has caused our elected officials and regulators to discard the rule of law and contracts in favor of expediency and with serious negative effects on the mortgage finance industry.
As we discussed in my previous column, "GSEs must finance the default wave," the government-sponsored enterprises such as Fannie Mae, Freddie Mac and the Federal Home Loan Banks are backing away from the mortgage market, with disastrous consequences for loan servicers and ultimately the GSEs themselves.
This past week, Federal Housing Finance Agency Director Mark Calabria stated that he was directing the GSEs to "add liquidity" to the markets, but the actions of the FHFA say precisely the opposite. By refusing to honor contractual obligations to seller/servicers in the conventional market, the GSEs are undermining investor confidence in the world of mortgage backed securities.
Bonnie Sinnock reports ("What the FHFA advance cap does — and fails to do — for servicers") that the FHFA's policy on capping advances of principal and interest on loans in forbearance does little to clear up the confusion that has prevailed since Calabria began to limit GSE support for the secondary markets.
While servicers welcomed the clarity provided by the FHFA this week on the key question of advances on forbearance loans, there remains a larger question: will the GSEs reimburse servicers for the four months’ worth of advances and when?
By stating that the GSEs will not follow industry practice and their contractual obligations to bank and nonbank loan servicers, Calabria is essentially telling the markets that the GSEs are headed for default. By reneging on the GSEs obligation to reimburse advances as incurred, the FHFA is essentially telling the world that Fannie Mae and Freddie Mac cannot or will not fulfill their contractual obligations.
When the FHFA subsequently announced that the GSEs could purchase conventional loans in forbearance that were stuck in lender pipelines, albeit at a 7% penalty discount, the industry and the MBS markets reacted negatively. While the GSEs have a contractual duty to purchase delinquent loans at par, the FHFA has essentially decided to take an involuntary loan equal to four months of P&I advances from bank and nonbank servicers to bail out the GSEs.
"The response today by Fannie Mae and Freddie Mac and FHFA to borrowers going into forbearance on GSE loans in the wake of the COVID-19 crisis is totally inadequate," said the Community Home Lenders Association. "Instead of providing a lifeline to conventional lenders and the borrowers they serve — as Congress and the administration have done for almost all other sectors of the economy — today's announcement amounts to little more than a GSE willingness to be a lender of last resort, a player in the scratch and dent market."
When mortgage market participants read the FHFA announcement regarding forbearance loan repurchases, more than a few expressed puzzlement. Given that the GSEs have a contractual obligation to purchase delinquent loans at par, what does it say when the FHFA takes away 7 points in loan level pricing adjustments to make a 93 bid for these loans?
"The servicers appear to face a deliberate strategy designed by the Federal Housing Finance Agency to stick the private market with the cost of dealing with COVID-19 in the conventional loan space," says Michael Bright, former Ginnie Mae COO and now CEO of the Structured Finance Association.
"This is not a reluctance to bail out private nonbanks with public funds, as some have argued. Instead, this looks more like the expropriation of private resources of banks, nonbanks and bond investors to shield Fannie Mae and Freddie Mac," he adds.
At the start of 2020, a number of members of the Trump administration harbored ambitions to see the GSEs exit conservatorship next year, but this agenda is now likely dead. Until the GSEs work their way through the credit costs of the response to COVID-19, which could be much higher than the 2008 credit crisis, any thoughts about taking the GSEs out of conservatorship are on hold.
But more important than short-term market conditions, the behavior of the FHFA when it comes to managing risk to the GSEs is doing long-term damage to the conventional loan market. For example, the new FHFA rules on loan purchases exclude cash-out refinance mortgages.
Mark Calabria and the FHFA presumably have reasons why they believe cash-out refinances should not be eligible for purchase by the GSEs. But they are a government regulator, part of the same government whose laws are made by elected officials in Congress, not by political appointees like Calabria. While many mortgage bankers saw the obscene pricing of forbearance loans in the FHFA announcement, they missed the part about excluding cash out refinance mortgages.
If Congress determined that cash out refinance borrowers are entitled to the same forbearance relief as other borrowers, why does Calabria believe that he has the right to undermine the will of Congress by refusing liquidity for that particular segment of consumers? As with the apparent default by the GSEs on their loan purchase and reimbursement duties, there is as yet no answer from the FHFA to these questions.
It is no stretch to see a causal chain flowing from the FHFA decision to exclude cash out refi loans. Consumers will pay higher rates and receive more restrictive terms for cash out refinances, this at a time of national crisis when they need this type of loan most. In general, the GSE pullback from such areas as cash out refinance, specified pools and adjustable-rate mortgages have badly hurt the most vulnerable, low-income consumers.
Calabria has spoken at length about limiting moral hazard from the GSEs that could impose costs on the taxpayer. But if we recall that the GSEs, properly seen, are actually providers of subsidies to the housing markets, then the FHFA's recent decisions are clearly a negative for market liquidity and the health of the conventional loan market.