Tag Archives: secondary mortgage market

Default Dean Adds To His Tea Party Creds

Dean Heller DoubleOn Halloween 2013 Senator “Default Dean” Heller (R-NV) voted to sustain the Senate Republican filibuster of  Congressman Mel Watt’s nomination to be the Director of the Federal Housing Finance Agency. [roll call 226]   “Default Dean” added another Gold Star to his Tea Party Helper chart with his next vote, another vote to sustain a filibuster — this time of the nomination of Patricia Millett to fill a vacancy on the D.C. Circuit Court of Appeals. [roll call 227] * see previous post and The Republican Argument is Bogus. (pfaw)

Some Republicans groused that Rep. Watt, a Yale Law graduate with extensive experience in North Carolina politics, and a Congressman from N.C. in several sessions “lacked the experience to administer an agency as large as the FHFA.”   By the end of the day on October 29th it was obvious there were going to be Senate Republicans who would block an “up or down” vote on Watt’s nomination. [Reuters]

It would be instructive at this point to mention that the Federal Housing Finance Agency is the outfit that oversees Fannie Mae and Freddie Mac, the Mortgage Twins, and the objects of GOP calls for a full privatization of the secondary mortgage market.  Additionally, it should be noted that Rep. Watt’s nomination is the second to be blocked by Senate Republicans; former N.C. banking commissioner Joseph Smith withdrew his nomination to head FHFA in 2011 in the face of GOP opposition.  Finally, Rep. Watt is on record as supporting measures to allow bankruptcy judges to trim the principal owed on home loans.  It appears that this position is sufficient to render his service on the House Financial Services Committee inadequate to Republican purposes.  [BloombergNews]

Given the opposition to both Smith and Watts a sentient person could logically conclude that in this instance the GOP doesn’t want the FHFA to be fully functional.   If the deregulation of the secondary mortgage market is the desire outcome, and the repeal of the oversight agency is impolitic, then the obvious way to impede the regulatory process is to keep the agency headless.  That sentient person could also conclude that St. Peter’s nomination would be blocked, on the grounds that his previous experience was only as a “community organizer” and that his most recent housing experience comes solely from his residency in a gated community.

Senator Heller’s opposition fits neatly into this scenario when we notice that he is a supported of S. 1217 — a bill to privatize the secondary mortgage market.

“In 2008, Fannie Mae and Freddie Mac were taken into government conservatorship and given a $188 billion capital injection from taxpayers to stay afloat. As a result of this bailout, the private market has almost completely disappeared, and so nearly every loan made in America today comes with a full government guarantee.  Despite this unsustainable situation, there has still been no real reform to our housing finance system since the financial crisis.”  [Heller]

The statement from Senator Heller doesn’t whitewash history — it merely leaves out a significant piece — like anything that happened prior to 2008.  Prior to 2008 the Mortgage Twins were hybrid-privatized secondary market financial agencies, and in the process of behaving like privatized secondary market finance operators they succumbed to the same avarice infecting the rest of the secondary home loan market — cutting back on home loan requirements and passing along risky financial products in the name of “managing risk.”   Further, there was a ‘silent agreement’ implicit in the operations of the Mortgage Twins before 2008 that the products it sold into the financial market did have the imprimatur of the federal government.

To boil things down to the core — what Senator Heller’s support of S. 1217 means is that he wants a return to the pre-2008 system, without any federal regulation of the secondary mortgage market at all.  Why would Senator “Default Dean” Heller want to confirm any nominee to head the FHFA when he’s supporting a bill that would eliminate Fannie Mae, Freddie Mac, and the FHFA within five years of the bill’s passage?

S. 1217 is warmly supported by the American Bankers Association and the Mortgage Bankers Association, and why shouldn’t it since it contains the following lovely loophole:

“Amends the Securities Act of 1933 and the Securities Exchange Act of 1934 to exempt covered securities insured by FMIC from Securities and Exchange Commission (SEC) regulation in general and from credit risk retention requirements…”  [OC]

The “FMIC” is supposed to be modeled on the FDIC, and notice that according to S. 1217,  introduced by Senator Bob Corker (R-TN), if the FMIC issues any “securities” those are exempt from regulation by the SEC.   Those who like deregulation of the financial markets will love this one.

Time and again, Senator Heller is fond of telling anyone who happens to be within range that he “voted against the bailout” as if he were somehow beyond the pressure of the lobbyists from the Mortgage Bankers Association and the American Bankers Association — and yet rarely can one find a Senator so ready and willing to carry the water for MBA and ABA interests.

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Filed under Economy, Heller, Nevada politics, Politics

Playing Risk: Nevada and the secondary mortgage market

Risk game boardThere are some topics which engender eye-rolling and extended yawns, and the secondary mortgage market is one of them.  That peril acknowledged, Nevada’s housing market is precariously balanced on the edge of this subject, so it’s worth risking another foray.  Let’s start with an article in the Las Vegas Sun,  concerning the implications of the Obama Administration’s decision to wind down the Mortgage Twins — Fannie and Freddie — in the backwash of the Mortgage Meltdown.

Blue BookA Quick Review

The focus of the article concerns the (1) possibility of increased mortgage rates in a fully privatized secondary mortgage market, (2) pressures on first time home-buyers which could be exacerbated by a privatized mortgage market, and (3) problems with establishing home values.

What is the Secondary Mortgage Market?

Here’s the standard definition:  “The market where mortgage loans and servicing rights are bought and sold between mortgage originators, mortgage aggregators (securitizers) and investors. The secondary mortgage market is extremely large and liquid.”  [Investopedia]

The mortgage originators (banks & other lenders) sell their home loans to “aggregators” who securitize (package the mortgages into bonds) and sell them to investors.   The second sentence in the definition might well qualify for inclusion in the Understatements Of The Century awards.

The idea behind this “large and liquid” — or Big and Squishy — system is to minimize RISK.  The bankers don’t have to keep all their loans on their own books, thus reducing their exposure to defaults, and the aggregators can re-package loans in ways to attract investors who want yield without too much RISK.  We’ve already covered all those intriguing and creative “financial products” (swaps, etc.) manufactured to further reduce RISK — which in some circumstances (read 2008) can create even more RISK.

Risky Business

There is one crucial point in the Sun article which should point us toward the critical problem with immediately  privatizing the secondary mortgage market:  What’s the value of the property on which the mortgage is based, and is the foundation for the securitization in the secondary phase?

If home values stabilize or increase the homeowners are more likely to be able to pay and not default on the loans.  When home values decline, as we learned to our peril, “underwater” home-owners are more likely to default which, in turn, de-values the aggregated and securitized ‘packages’ sold to investors.

Blue Book

The Rules of the Game

While those interviewed for the article use the term “guidelines,” let’s call those The Rules of the Mortgage Market Game.  One of the functions of the “Mortgage Twins” is to establish basic rules for home loan lending.  The Congressional Budget Office analysis explains:

“They purchase mortgages that meet certain standards from banks and other originators, pool those loans into mortgage-backed securities that they guarantee against losses from defaults on the underlying mortgages, and sell the securities to investors–a process referred to as securitization. In addition, they buy mortgages and MBSs (both each other’s and those issued by private companies) to hold in their portfolios. They fund those portfolio holdings by issuing debt obligations, known as agency securities, which are sold to investors.”

The two essentially risk reduction elements are in the first part of the explanation quoted above. (1) Fannie and Freddie have mortgage lending standards.  (2) Fannie and Freddie operate as aggregators who will re-sell the mortgage packages to investors.

When the banking system collapsed in a heap in 2008, the Mortgage Twins ended up holding most of the bag.

“…in 2009, the two GSEs owned or guaranteed roughly half of all outstanding mortgages in the United States (including a significant share of subprime mortgages), and they financed three-quarters of new mortgages originated that year. Including the 20 percent of home loans insured by federal agencies, such as the Federal Housing Administration (FHA), more than 90 percent of new mortgages made in 2009 carried a federal guarantee.” [CBO]

Not to put too fine a point to it, but when the banking system took on too much risk during the Housing Bubble, the explicit federal guarantee for the secondary mortgage market backstopped the home loan lending process in this country, and in this state.  That’s the good news.  That doesn’t mean there aren’t still some intrinsic problems with the Mortgage Twins.

The Backstop Effect:  Little encourages more risky behavior than the notion that someone else will end up holding the bag.  As long as the federal government assumes responsibility for the home loans, then the bankers can see the system as one that privatizes the profits and socializes the risks.   This rationalizes the practice of offering exotic home loan products to people who might never have qualified otherwise.

The Quis custodiet ipsos custodes?  Factor:  Who was watching the watchers before 2008?  Before 2008 the Mortgage Twin’s regulators lacked the authority to increase the capital requirements for Fannie and Freddie.  Nor could the regulators place the Twins in receivership as the government could in the instance in which a bank went under.  No one should have been surprised when the Twins were placed in conservatorship in the wake of the Housing Bubble deflation.

There’s little appetite from most quarters to leave the current system in place.  However, the next step in the reform process must address some difficult questions.

Blue Book  “Students are required to provide their own 8½ x 11 bluebooks. Do not use the smaller sized bluebooks. Bluebooks are available at the University Bookstore. The exam proctor will also always have some emergency blue books available.”  [Law.Wash.EduAnd the test questions are:

#1.  What configuration for the secondary mortgage market will best ensure a stable supply of mortgage financing?   Consider the consequences of a fully public model, a hybridized public-private model, or a fully privatized system.

#2. How are the underlying assets to be valued? Your answer should give consideration to (a) the standards by which the quality of the underlying loans are to be evaluated, (b) who should establish the standards for this evaluation, and (c) how the housing finance structures might be affected by the needs of the banking sector, the construction sector, and the needs of middle income prospective home-buyers.

— Good Luck —

For a fuller look at some possible answers, see Congressional Budget Office, ” Fannie Mae, Freddie Mac, and the Federal Role in the Secondary Mortgage Market” December 22, 2010.   New York Times, “Washington Steps Warily on Housing,” August 6, 2013.   New York Times, “Obama Outlines Plans for Fannie Mae and Freddie Mac,” August 6, 2013.   Federal Reserve Bank of Atlanta, “Financial Market Update, Volume 14, No. 1: Fannie Mae and Freddie Mac at work in the secondary mortgage market.”  University of North Carolina, Center for Community Capital, “Fannie, Freddie, and the Foreclosure Crisis,” September 2010.

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Filed under housing, Nevada economy

The Big Lie and the American Consumer

One conservative script describing the current sluggish U.S. economic recovery implies “that Americans (especially middle-income Americans) are slothful, selfish louts who refuse to understand the country’s future depends on their willingness to give up luxuries like Medicare, Social Security, public education and collective-bargaining rights.” [WashMonthly] Ed Kilgore concludes:

“With relatively few non-economists noting it, the U.S. has been rapidly shedding private-sector debt—or “deleveraging”—during the Great Recession, to the point where total debt is actually declining.”

So, Enough Consumer Bashing Already.  However, by  conservative lights the Recession was the consumer’s fault, and this excerpt provides an example of that thinking:

“We need widespread agreement that greatly increased bad consumer debt is a root cause of our current problems, and that bad credit leads to the deflationary effect on prices. If we can agree on that, we would probably hold better public discussions on the best actions for government to take to deal with the problem.”  [SeekingAlpha]

If this argument is to hold any water, then surely we would have seen increasing  “bad consumer debt” right up to the Big Crash in the fall of 2008? But we didn’t. A chart of consumer credit obligations, in the form of the Federal Reserve’s Financial Obligations Ratio, looks like this:

A cursory look at the graph shows consumers “de-leveraging” as of the 3rd quarter of 2006.  The statistics from the Federal Reserve do not support the conclusion that increasing consumer “bad debt” was the proximate cause of a financial sector collapse two years later in 2008.

What was increasing in 2006 was the ratio of household debt related to mortgages.

And from whence did the mortgages come?   Moody’s Analytics (pdf) provides this illustration:

The private label part is important.  The securitization process meant that more banks were scrambling for a larger portion of the Mortgage Pie (read: market share) and in the process issued mortgages that did not conform to previous standards.

“Private-label mortgage backed securities are securitized mortgages that do not conform to the criteria set by the Government Sponsored Enterprises Freddie Mac, Fannie Mae and Ginnie Mae.  The mortgages that make up these securities do not have the backing of the government and as a result carry a significantly greater risk. ” [Securitization]

In the midst of their enthusiasm for gaining market share of asset based securities, the Wall Street Wizards evidently overlooked the part wherein the non-conforming mortgages carried a “significantly greater risk.”   They were counting on the government sponsored agencies to bail them out if they got into trouble, as this excerpt indicates:

“Private-label mortgage securities, whether pass-throughs or Collateralized mortgage obligations (CMOs), are the sole obligations of their issuer and are not guaranteed by any governmental entitiy. However, many private-label CMOs are backed by pass-through securities issued or guaranteed by Ginnie Mae, Fannie Mae or Feddie Mac, meaning that collateral backing these securities carries the respective agency’s or government-sponsored enterprise’s guarantees. ” [Brighton]

Reality Check Time:  There was no explicit government guarantee for the non-conforming mortgages, and the nationalization of Fannie and Freddie salvaged the secondary mortgage market by making the implicit explicit. The banks ended up with the collapse of Lehman Brothers, and the subsequent tax payer funded rescue of their “private label” banking institutions.
Homeowners were caught in the back wash, and the FOR ratios started dropping in the 1st quarter of 2008.  [FED]

There are a couple of lessons to be learned from the debacle of the Housing Bubble and the subsequent sluggish recovery.

(1) Consumers started de-leveraging long before the bankers engaged in the process.  Consumer credit ratios began declining in the 2nd quarter of 2005.

(2) The race to secure “market share” in the mortgage, and secondary mortgage markets, was the result of management decisions to increase the number of non-conforming mortgages for securitization, and to increase revenues therefrom.

Far from being those “selfish, lazy, louts” who don’t understand finances (even their own) American consumers were decreasing their own levels of indebtedness long before it occurred to the bankers that they should take the same precautions.

Secondly, those consumers would not have fallen for the siren songs of mortgage originators for exotic mortgages had those originators stuck to the standards in place prior to the Bubble and its ingenious “adjustable rate, no-doc, substandard” loans.  Had these loans not been made so readily available fewer homeowners would now be further “de-leveraging” as they attempt to scramble out of the morass of declining home values.  If this is what passes for “creativity” in the mortgage market we could have certainly done with less of it.

Continuing arguments from the Financialists and their political allies which seek to place the onus for the recession and slow recovery on the transgressions of American consumers are merely self-serving excuses for their desire to be minimally regulated in a system in which the rewards are privatized and the risks are socialized.

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Filed under conservatism, Economy, financial regulation